Key Takeaways
- Apportionment is how states split your business income across the states where you operate so each state taxes its “share.”
- Most states use a formula based on sales, payroll, and property. Many states now use sales-only (single-factor sales apportionment).
- For online businesses, the apportionment factor that matters most is where your customers are (sales sourcing).
- Apportionment applies to C-Corps directly. For pass-throughs (LLCs, S-Corps), the profit flows to the owner’s personal return, and the owner pays based on residency, not apportionment.
What Apportionment Is
If your business has income in multiple states, each state wants its cut. Apportionment is the formula each state uses to decide how much of its total business income is “its” income.
Example: you run an NYC S-Corp with $500K in profit. Customers are 60% in New York, 30% in California, 10% everywhere else. If California uses single-factor sales apportionment, California says 30% of your profit ($150K) is Californian and taxes it accordingly.
The Formulas
Three-factor formula (older approach)
[(Sales in state / Total sales) + (Payroll in state / Total payroll) + (Property in state / Total property)] / 3
Used by some states. The three factors are averaged.
Single-factor sales apportionment (the modern trend)
Sales in state / Total sales
Many states moved to this because it attracts businesses (out-of-state companies with lots of in-state sales but no in-state employees pay more).
New York applies a single-factor sales apportionment for both C corporations and pass-through entities, meaning that only receipts sourced to New York are considered in determining the apportionment percentage. For pass-through entities, this impacts how income flows through to owners based on New York–sourced receipts. New York City follows a similar single-sales-factor approach; however, it operates under a separate tax regime with its own rules and calculations, particularly under the NYC Business Corporation Tax and Unincorporated Business Tax. As a result, businesses operating in both jurisdictions must evaluate apportionment separately for New York State and New York City purposes.
Why This Matters for Online Businesses
Online businesses have minimal payroll and property out of state, but their sales are everywhere. Single-factor sales apportionment means more of your income gets allocated to the states where your customers live, not where your team or office is.
For NYC online sellers: if your customers are heavily concentrated outside NY, apportionment might actually reduce your NY state tax burden (because less of the profit is apportioned to NY). For NYC sellers whose customers are mostly in NY, apportionment doesn’t help.
Pass-Through vs C-Corp
Apportionment applies to C-Corps at the entity level. Each state taxes its apportioned share.
For pass-throughs (LLCs, S-Corps), the business itself usually pays little to no entity-level income tax. Profit flows through to the owner, and the owner pays based on their personal residency. If the pass-through has activity in multiple states, the owner files non-resident returns in those states and claims a credit in their resident state.
Sourcing Rules (The Tricky Part)
“Sales in state” means different things to different states. This is called sourcing.
- Cost-of-performance sourcing (older): Sale is sourced to the state where the work was performed. Good for service businesses operating out of NYC.
- Market-based sourcing (modern trend): Sale is sourced to the state where the customer received the benefit. Harder for service businesses.
For SaaS / digital services, revenue is sourced to where the customer receives the benefit; NOT where the business operates, aka customer-based sourcing.
Frequently Asked Questions
How do I allocate income across states?
Each state has its own formula. Most common: single-factor sales apportionment (your sales in that state divided by total sales). Multiply that percentage by your apportionable income to get the amount taxed by that state.
Do I pay tax in every state my customers live in?
Only in states where your business has income tax nexus (usually similar thresholds to sales tax nexus, sometimes lower). Having customers in a state doesn’t automatically mean you file an income tax return there.
What is apportionment?
The formula each state uses to determine how much of your total business income is taxable in that state, based on how much of your sales, payroll, and property are in the state.
Case Story: Multi-State Music Business
The situation: Two partners headquartered in NYC and California, booking talent across the US, Canada, and Mexico. Found Anil during COVID, 5 days before the deadline.
What Anil did: Allocated income across the multiple states where they did business, reducing tax burden in the two highest-tax states. Added a defined benefit pension plan for additional savings.
Outcome: 5 to 7 percent tax savings on total income annually from multi-state allocation. Defined benefit plan saved ~$200K in one year on $500K contribution.
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