May 30, 2018

Maryland Begins Phase-in to Single Factor Apportionment

4 min

As a result of legislation passed in its 2018 legislation session, Maryland begins a five-year phasing-in of a single factor sales-based apportionment formula for multistate corporations beginning with the 2018 tax year. Maryland Chapter Laws 341 and 342.

Currently, Maryland corporations engaged in a unitary business in multiple states in addition to Maryland must use a traditional three-factor formula with a double weighted sales factor to apportion taxable income within and without Maryland for Maryland corporate income tax purposes. Thus, the factor consists of (i) the sum of the Maryland property factor, plus the Maryland payroll factor plus twice the Maryland sales factor (ii) divided by four.

The phase-in is implemented by increasing the sales factor weighting by one each year for the next five years such that it will be weighted by three for 2018 with a total divisor for the factor of five, and increasing each year until it reaches a weighting of six for the sales factor for 2021 with a divisor of eight. As of 2022, the Maryland apportionment factor switches over to be 100 based on the sales factor.

A new rule is added to address the means for inclusion of income from intangible assets (e.g., dividends, interest, royalties, and capital gain from the sale of intangible assets) in the numerator of the sales factor. Drawing on the method used in several other states, such income from intangible assets is allocated to Maryland for purposes of the sales factor numerator based on the average of the property and payroll factors.

Special rules are provided for two categories of businesses. First, no change results for manufacturing businesses. They currently file and will continue to file Maryland corporate income tax returns using a single sales factor for apportioning taxable net income to Maryland.

Second, a narrow category of select Maryland headquarters-based businesses were granted entitlement to continued use of the existing three-factor apportionment formula. This exception to the phase-in is added via designation of a new category of entity, a Worldwide Headquarters Company or WHC, which can elect to continue to use the three-factor double weighted sales factor apportionment methodology of existing law. Qualification as a WHC requires that the corporation (i) filed a Form 10-Q with the Securities and Exchange Commission for the quarterly period ending June 30, 2017, (ii) has its principal executive office in Maryland, and (iii) employs at all times between July 1, 2017 and June 30, 2020 at least 500 full-time employees at the parent corporation's principal executive office that is located in Maryland.

The Maryland Comptroller will need to add the election process for WHC status to its corporate income tax apportionment forms. And the Comptroller should include in the form's instructions or via regulations its interpretation as to the meaning of "principal executive office," so as to guide businesses that must interpret this new term in evaluating their eligibility.

Maryland's change over to single-factor apportionment for businesses is consistent with a number of other states that have already made the same transition (increasing from only six states in 2001 to almost half the states in 2018 using some form of single-factor apportionment formula). For a Maryland business that has a Maryland sales factor that is lower than the average of its payroll and property factors, the transition should result in a reduction of the business's Maryland income tax liability that would otherwise result. Conversely, the transition to single-sales factor apportionment tends to increase the Maryland tax liability of business with payroll and property primarily located in other states, but that sell their products and services into Maryland.

Presumably, this change will also apply to source Maryland income for nonresident individuals and pass-through entities with nonresident owners, including S corporations, partnerships, limited liability companies, business trusts, and statutory trusts. Under the Comptroller's regulations and instructions to tax returns, nonresident individuals and pass-through entities make use of the apportionment formula applicable to corporations in a variety of circumstances. We should expect that the Comptroller will update these regulations and instructions to clarify the application of single-sales factor apportionment to nonresident individuals and pass-through entities.