What Is the Throwback Rule?
The "throwback rule" is a statute that states can adopt and use to ensure corporations pay their state taxes on 100% of their profits. Every state that levies a corporate income tax must determine, for each company doing business within its borders, how much of the company’s profits it can tax.
Traditional state apportionment computations base state corporate taxes on a formula that considers where a corporation's property, payroll, and sales are located. These formulas result in "nowhere income," or income on which a corporation does not pay tax in any state. The throwback rule is meant to eliminate this tax loophole and cut down on corporate tax avoidance.
How the Throwback Rule Works
Under traditional taxation formulas used by states, some income is left un-taxable as "nowhere income." Critics consider such traditional apportionment formulas unfair to small businesses that have profits that are 100% taxable because all of their business activities are located in a single state. These businesses end up paying taxes on a greater percentage of their profits than some multi-state corporations do.
Critics also think that multi-state corporations with "nowhere income" are burdening state residents by not paying for their fair share of public services and that the corporate income tax has declined significantly as a source of state revenue as a result of the "nowhere income" loophole.
The best state remedy for the problem of nowhere income is enacting a so-called “throwback rule,” which mandates that sales into other states or to the federal government that are not taxable will be “thrown back” into the state of origin for tax purposes. In other words, the throwback rule is a backup for the destination rule: when the destination rule assigns a sale to a state that can’t tax that sale, the sale is re-assigned back to the state that is the source of the sale.
One alternative to the throwback rule is the “throwout rule” previously used by New Jersey and West Virginia. Rather than seeking to assign all sales to the states in which the company operates, the throwout rule simply excludes from overall sales any sales that are not assigned to any state.