Indiana Repeals Throwback Rule for Income Tax

One of the biggest Indiana tax changes arising from the 2015 Indiana General Assembly was the repeal of the sales factor “throwback rule” as part of Senate Bill 441 passed by the General Assembly on April 29. The main intention of SB 441 was to simplify the Indiana tax code to reduce paperwork burdens for Indiana businesses while also incentivizing Indiana investments. The throwback repeal law will be effective for tax years beginning after 2016 and will greatly impact how sales are apportioned to Indiana.

Under prior theories of states’ tax laws, all of a company’s sales would be attributed to the states in which it operated; however, due to differences among various states’ business income tax rules, this is often not the case. In some instances, a portion of a business’ sales are not attributed to any state, which means that a corresponding portion of the company’s profits go untaxed – referred to as “nowhere income.” Many tax-savvy businesses aware of this loophole set up operations to maximize nowhere income and thus minimize taxes they owe. In 2016, Indiana will become such a state where these tax-savvy businesses can now thrive (at least for state income tax purposes).

Pre-2016 Indiana law provides that sales of tangible personal property are considered to take place in Indiana when property is shipped from an office, store, warehouse, factory or other place of storage in the state and the purchaser is the United States, or the taxpayer is not taxable in the state of the purchaser regardless, effective January 1, 2007, of the f.o.b. point or other conditions of the sale. Thus, taxpayers are not subject to the throwback rules on non-Indiana destination sales into states in which they are taxable since, in theory, they will now be taxed on those sales in the non-Indiana destination state.

Conversely, under pre-2016 rules, taxpayers who ship tangible personal property from Indiana to a purchaser located in a state where the taxpayer is not subject to tax are then required to "throw back" such sales for purposes of computing the Indiana apportionment factor numerator (i.e., include in Indiana’s sales factor).

Indiana will now join its non-throwback neighboring states – Michigan, Ohio, and Kentucky – beginning in 2016, with the result being non-U.S. government sales of tangible personal property shipped from Indiana to a non-Indiana destination will not be sourced to Indiana even if the taxpayer is not taxable in the purchaser’s state.

Taking into account the red-line changes shown in SB 441, the revised law (effective for tax years beginning January 1, 2016) will read:

Regardless of the F.O.B. point or other conditions of the sale, sales of tangible personal property are in this state if:

1. The property is delivered or shipped to a purchaser that is within Indiana, other than the United States government; or
2. The property is shipped from an office, a store, a warehouse, a factory, or other place of storage in this state and the purchaser is the United States government

Some important considerations when reviewing applicability of the revised Indiana sales factor:

1. These provisions relate only to sales of tangible personal property, NOT intangible product sales or services.
2. Treatment of sales to the U.S. government has not changed. Thus, all sales to the U.S. government (no matter where shipped) will continue to be sourced to Indiana. (Some states e.g., Michigan and Kentucky, have/do treat U.S. government sales differently.
3. These provisions only relate to income taxes and not other types of taxes imposed by Indiana e.g., sales taxes could still be required to be collected in Indiana even if eventually shipped outside of Indiana.
4. Many other states with similar non-throwback provisions have modified these rules in administrative regulations with further requirements (e.g., Michigan requires that a taxpayer must be taxable in at least one other state for non-throwback rules to apply).

Who benefits under this law change:

• Indiana-based C Corporation taxpayers shipping goods from Indiana into other states not having an income tax (e.g., Washington, Nevada)
• Indiana-based C Corporation taxpayers in which the Indiana seller does not have income tax nexu
• Indiana-based S Corporations/Partnerships (LLC) with non-Indiana resident owners who reside in non-income tax states (e.g., Florida, Texas)

If you have questions about this or thoughts on other types of taxpayers who can benefit under this future law, please comment below.

Written by: Jeff McGowan, CPA, CGMA
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Phone: 574.289.4011, x245

*This blog post also appeared in the Indiana CPA Society Center of Excellence Blog.