Although I have discussed market-based sourcing several times, a quick recap is in order. Rather than looking to the traditional criteria of cost of performance or where the services were actually performed, market-based sourcing purports to look to where the customer received the benefit of the services provided.
Market-based methodology has been a great economic development incentive for state and local tax jurisdictions. Combined with a single factor apportionment scheme based only on sales, businesses are encouraged to locate their offices, property, equipment, employees, and all other valuable assets within the jurisdiction. Taxpayers can do so with no increase in tax liability as the location of their business will have no impact on the income tax liability of the business. Only in-state customers will potentially generate an apportioned tax liability to the taxing jurisdiction.
States have been jumping on the bandwagon so as to stay competitive with one another. If State A has market-based sourcing and State B has the traditional three factor formula or even one factor based on sales, all other things being equal, the taxpayer has an incentive to locate in State A. This strategy can work out great for states and great for taxpayers.
However, the relative newness of the market-based concept and the relative slow rate of change inherent in tax laws can generate some unpleasant surprises for the unprepared taxpayer. While some jurisdictions have consistently adopted market-based sourcing across all of their taxing schemes, others have not. Localities can be at issue as well. So a taxpayer that is a corporation may reap the benefit of market-based sourcing, while an LLC or partnership might still be subject to the old rules. Similarly, sole proprietorships can fall into this trap.
While we urge all jurisdictions to apply the rules regardless of the form the business operates, it is going to take some time and in some cases, may never happen. Taxpayers along with their advisors need to be diligent in understanding the inconsistencies in the rules.
If you have concerns or questions about the application of market-based sourcing, contact me at firstname.lastname@example.org or your Berdon Advisor.
Wayne Berkowitz, a tax partner and head of the State and Local Tax Group at Berdon LLP, New York Accountants, advises on the unique requirements of governments and municipalities across the nation.