This Week in State Tax

A California Superior Court, in a proposed decision, held that a taxpayer was entitled to use a three-factor apportionment method, rather than California’s default single sales factor apportionment method. The taxpayer operated a business that raised and harvested hogs, processed meat, and sold fresh and packaged pork products. In 2014, the tax year at issue, the taxpayer operated several types of facilities, including farms, feed mills, harvesting facilities, and meat packing facilities. Only one of the taxpayer’s 30 processing facilities was in California. The taxpayer initially filed its 2014 California income tax return as a non-agricultural business apportioning income to California based upon the prescribed single sales factor formula. California law mandates single sales factor apportionment unless the taxpayer engages in a statutorily enumerated activity, including agricultural business activity, which requires that more than 50 percent of gross receipts be derived from agricultural activities. The taxpayer then filed a refund using a three-factor apportionment method, arguing that (1) it was an agricultural business, (2) the regulation applicable to agricultural business activities was overly narrow and invalid, and (3) it was entitled to alternative apportionment as the single sales factor formula did not fairly represent its in-state business. The state Franchise Tax Board (FTB) did not act on the claim, and the taxpayer treated the refund claim as denied and appealed to the court.

At trial, the FTB argued that the taxpayer was not an agricultural business because the applicable regulations apply a “product-based” approach that looks solely at the character of the final product sold by a taxpayer to determine if it is engaged in agricultural activities. The Court disagreed, noting that all the activities related to hog production qualified as agricultural business activity. The court ultimately found that over 60 percent of the taxpayer’s total receipts from fresh pork products and packaged meat products were attributable to the hog production and harvesting activities (i.e., agricultural business activities). Thus, the taxpayer was entitled to use a three-factor apportionment method. The court also noted that the regulation which used a product-based approach to determine “agricultural business activity” was inconsistent with the statutorily prescribed test that specifically looks at a taxpayer’s activities and gross receipts derived therefrom, and is thus invalid both under California law and as applied to the taxpayer in this case.

The court also upheld the taxpayer’s alternative apportionment argument, finding that using a three-factor apportionment method was a reasonable method to fairly represent the taxpayer’s business activity in California. Although not statutorily defined, the court noted that business activity “encompasses more than simply the ultimate revenue-generating item … It also includes activities of employees, as reflected in the payroll factor, and the use and availability of real and tangible and intangible personal property.”​ Here, all the taxpayer’s hog production facilities, harvesting facilities, and processing facilities (except one small plant) were outside of California. These facilities were necessary for the taxpayer’s business and were the primary drivers of its income. Moreover, the taxpayer’s employees at these various facilities were necessary to engage in its business. Thus, according to the court, a single sales factor did not fairly represent the taxpayer’s business because it disregarded substantial activities, which occur “almost entirely” outside of California. Applying a three-factor method, the taxpayer’s business activities in California were just over one percent of its total activities, contrasted with the single sales factor which attributed over 6.5 percent of the income to California . This 600 percent difference justified the use of alternative apportionment as applied to the taxpayer. Please contact Candace Axline and Geoffrey Way with questions about Smithfield Packaged Meats Corp. v. Franchise Tax Bd., Cal. Super. Ct., No. 21STCV39637 (Feb. 26, 2026).

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The United States Supreme Court has denied a writ of certiorari relating to ongoing New Jersey litigation over the deductibility of royalty payments made to a related party. Under New Jersey law, royalties paid to a related party must be added back in determining taxable income, but a deduction is allowed if the taxpayer can show that the adjustments are “unreasonable.” Prior to 2020, the “Unreasonable Exception” applied only to “the extent the payee pays tax to New Jersey on the income stream” (geographic limitation). The Division removed the geographic limitation in 2020. In the petition to the Supreme Court, the taxpayer argued that “[b]y permitting an addback only to the extent of the New Jersey activity of the royalty recipient and taxing the royalty income received by the royalty recipient using the royalty payor’s apportionment factor,” New Jersey was violating the Commerce Clause and Due Process Clause. In the taxpayer’s view, the New Jersey addback created an incentive for intrastate activity over interstate activity. On the state level, the New Jersey Superior Court, Appellate Division determined in 2025 that by amending the regulation in 2020, New Jersey “cured” the unconstitutionality of the geographic limitation. The New Jersey Supreme Court declined to review the appellate court which led to taxpayer’s petition to the U.S. Supreme Court. Please contact James Venere and Andrew Eskola with questions on Lorillard Tobacco Co. v. Sciarrotta, U.S., No. 25-769, cert. denied Mar. 3, 2026. 

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See below for recent state legislation and guidance on conforming to or decoupling from the One Big Beautiful Bill Act (P.L. 119-21) (OB3).

Indiana: Both chambers of the Indiana General Assembly have passed and Governor Braun has signed a bill to update the state’s fixed date of conformity to the Internal Revenue Code (IRC) to the IRC as amended and in effect on January 1, 2026. However, under the bill, Indiana would decouple from IRC section 168(n) (bonus depreciation for qualified production property). Indiana will also continue to allow a full deduction for both foreign and domestic research and experimental expenditures, and it had earier decoupled from bonus depreciation under IRC section 168(k). The bill is effective January 1, 2026; it contains provisions indicating that amendments in OB3 that were effective for tax year 2025 at the federal level are also effective for tax year 2025 for state purposes.  The individual tax provisions allowing a deduction for certain tip income, overtime pay, and automobile loan interest are adopted for tax year 2026 only. Please contact Gianluca Pitetti and Ryan Dahlkamp with questions on Senate Bill 243.

Michigan: Following Michigan’s FY 2026 budget decoupling from several OB3 provisions, the Michigan Department of Revenue released guidance on required corporate income tax adjustments. [For more detail on Public Act 24, see our TWIST of October 13, 2025]. Under the guidance, corporate taxpayers must calculate their Michigan IRC §163(j) limitation without depreciation, amortization, or floor plan financing interest on trailers or campers. Differences from the federal deduction are reported as additions or subtractions, requiring tracking of Michigan unused interest carryforwards. Further, as it relates to IRC 168(n), the guidance provides that taxpayers must recompute federal taxable income using the amount of depreciation deduction that would otherwise been available if IRC 168(n) as adopted in OB3 was not in effect. Finally, with respect to IRC §174/174A, taxpayers must compute Michigan taxable income as if domestic R&E expenditures are amortized over five years. Taxpayers that elected to accelerate unamortized R&E expenses for TY 2022–2024 must add back the excess federal deduction and continue to deduct the expenses over the succeeding tax years. Please contact Dan De Jong and Arthur Orzame with questions on Decoupling Michigan Income Taxes from Certain Internal Revenue Code Provisions.

Minnesota: The Minnesota Department of Revenue issued guidance confirming that taxpayers will need to make adjustments to income on their Minnesota return as Minnesota does not adopt the federal changes under OB3. Recall, Minnesota conforms to the IRC, as amended through May 1, 2023. Minnesota has released the 2025 Schedule M4NC, Federal Adjustments to allow taxpayers to make the appropriate adjustments. For more information on 2025 Federal Nonconformity for Income Tax, please contact Dale Busacker.

West Virginia: West Virginia Governor Morrisey recently signed a bill updating the state’s conformity date to the IRC as amended and in effect on December 31, 2025, including the incorporation of all amendments to the IRC enacted after December 31, 2024, but prior to January 1, 2026. Thus, West Virginia effectively conforms to the changes made to the IRC by OB3. The bill is effective for tax years beginning on January 1, 2026, but are retroactive to prior tax years to the extent allowable under federal income tax law. For more information on Senate Bill 393, please contact James Kaczorowski.

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