United States: North Carolina Department Of Revenue Revises Apportionment Methods For Multistate Partnerships

In a directive dated October 10, 2014, the North Carolina Department of Revenue announced a change in its policy regarding the apportionment and allocation of income by multistate partnerships.¹ For partnerships, the Department may now approve the use of an alternative apportionment method. In addition, partnerships will no longer be allowed the option to separately report income from segregated business activities. Both policy updates are considered to be significant changes from previously enacted policy.

Background and Prior Policy

Under North Carolina law, a multistate corporation with business activity in North Carolina is required to allocate and/or apportion its income to the state. ² Generally, an entity having business activities which are taxable both within and outside North Carolina would be subject to this methodology. The general statutory method of apportionment consists of the entity's property factor, payroll factor, and double-weighted sales factor ("four-factor method").³ Alternatively, a corporation that believes this statutory formula allocates a greater portion of its income to North Carolina than is reasonably attributable to the state may provide a written request to the Secretary of Revenue for permission to use an alternative apportionment method.⁴

While partnerships are also required to use the statutory four-factor method of apportionment,⁵ the Department did not previously address the issue of alternative apportionment specific to multistate partnerships. In 1991, the Department issued a memorandum advising that, unlike corporations, partnerships may not request permission to use an alternative apportionment formula.⁶ Instead, a partnership with business operations in North Carolina that were fully integrated with its business operations in other states, commonly referred to as apportionable income, would be solely subject to the statutory corporate apportionment formula. Alternatively, a partnership with business operations in North Carolina that were not fully integrated with its business operations in other states, commonly referred to as allocable income, would need to separately account for the income earned in North Carolina.⁷

Revised Policy

The Department recently reviewed its position on apportionment and allocation of partnership income, and as described in the directive, has determined that the requirement for partnerships to use the ratio calculated under the corporate apportionment formula necessarily includes the use of an approved alternative apportionment method. The Department also concluded that it overstepped its authority by previously requiring partnerships to separately account for non-integrated business activities within and outside North Carolina. Instead, the Department generally will not allow partnerships to use separate accounting in this instance. These changes are effective for all tax years beginning on or after January 1, 2014.

As a result, a multistate partnership that believes the statutory apportionment formula attributes a greater portion of its income to North Carolina than is reasonably attributable to its activities in North Carolina may request permission to use an alternative formula that better attributes its income to North Carolina. Partnerships that previously accounted separately for segregated or non-integrated activities will only be permitted to continue using this methodology if the Secretary of Revenue authorizes it as an alternative apportionment formula.

The Department is revising its partnership income tax return form and instructions for the 2014 tax year to remove the provisions for reporting income from segregated activities. Accordingly, the tax return form will now include lines for nonapportionable income from North Carolina sources and apportionable income subject to North Carolina's apportionment provisions.

Commentary

The revised guidance from the Department provides significant changes for multistate taxpayers filing partnership returns in the state. The measures attempt to align North Carolina with constitutional apportionment methodologies and procedures. However, the changes may prove to be somewhat restrictive and less open to interpretation by taxpayers. If a partnership has already filed an original partnership income tax return for a tax year that began on or before January 1, 2014, the Department will not adjust the return to reflect the revised policy. However, the partnership may amend its return to reflect the revised policy, subject to North Carolina's statute of limitations. Any corrections to partnership income filed on an amended return are binding on each corporate or nonresident individual partner. A partnership cannot request an alternative apportionment formula for tax years beginning before January 1, 2014, though it may incorporate the revised policy changes in the directive related to apportionable and nonapportionable business income.

Footnotes

1 Directive PD-14-02, North Carolina Department of Revenue, Oct. 10, 2014.

2 N. C. GEN. STAT. § 105-130.4.

3 Id.

4 Id.

5 N. C. GEN. STAT. § 105-153.4.

6 Memorandum, North Carolina Department of Revenue, July 2, 1991.

7 Id.

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