To Throwback or Not to Throwback: California Nexus and Allocation Rules

Brian Gordon, CPA
Published Date:
Apr 1, 2014

The first thing a company must determine is whether it is required to file a California tax return. One longstanding part of California’s nexus law seemed simple: companies conducting business for profit in California had to file a tax return. But beginning in 2011, California established new economic nexus rules that made this process more complex. They also affected its allocation and throwback rules. (These rules are the same for corporations and partnerships.)

Economic Nexus

Under the new economic nexus rules, companies are considered to be doing business in California if they meet any of the following conditions:

  • They have property in California, with a value of $50,000 (subject to annual increases for inflation) or 25% of total property, whichever is less.
  • They have payroll in California, in the amount of $50,000 (subject to annual increases for inflation) or 25% of total payroll, whichever is less.
  • They have sales in California, in the amount of $500,000 (subject to annual increase for inflation) or 25% of total sales, whichever is less.

Regardless of these new rules, if the company has sales of tangible personal property (TPP) that exceed $500,000 (subject to annual increases for inflation), but its only presence in California is for solicitation of sales, it is still protected under Public Law 86-272, meaning that it does not owe tax on its California income; however, they are still required to file a California return and pay the minimum tax. If the sales are for services, there is no protection under Public Law 86-272, and the income will be taxed if they meet one of the three conditions above.


For 2011 and 2012, the three-factor formula described above was still in effect, with an option to use a single sales factor. Beginning with 2013, the single sales factor is required for most corporations, other than those involved in agriculture, mining, or banking.

Sales of TPP and Throwback Rules

California allocation rules have a provision that is referred to as “throwback rules.” New York, on the other hand, does not have these rules. A New York corporation will allocate sales to New York only when the shipping point is inside New York. Sales shipped outside of New York are included only in the denominator of the sales allocation factor as everywhere (total) sales. In New York, it does not matter if the corporation has nexus in any other state or if it is taxable in any other state for any reason.

On the contrary, California rules allow allocation outside California only to states where companies are subject to tax. An entity is subject to tax in another state when “in that state it is subject to a net income tax, a franchise tax measured by net income, a franchise tax for the privilege of doing business, or a corporate stock tax, or … that state has jurisdiction to subject the taxpayer to a net income tax regardless of whether, in fact, the state does or does not” (California Revenue and Taxation Code section 25122). When a California company ships sales of TPP to a state outside California where there is no nexus and it is not subject to tax, the sales are “thrown back” to California, and are included in the numerator of the California sales factor (because it is considered a California sale).

Since 2011, the new nexus rules have created a dilemma for California with regard to the throwback rule. Because California was able to create nexus rules subjecting new taxpayers to California taxation, these laws could subject companies to tax in other countries or in other states (if there was a sale of services; see below for more details). As such, California acknowledged in Chief Counsel Ruling (CCR) 2012-03 that the throwback rule will not apply where there are sales of tangible personal property in excess of $500 thousand to a foreign country. In other words, a company would be subject to tax in the foreign jurisdiction under the new California economic nexus rules; thus, there is no throwback. Sales of TPP to other states, however, do not result in taxability because companies are protected under Public Law 86-272; therefore, throwback is required. The California minimum tax requirement does not change this result.

Income from Services and the Throwback Rule

There are two methods that states use to allocate income from services: the market-based sourcing method and the cost of performance method. With market-based sourcing, income is allocated to the location where the customer receives the beneficial use of the service—generally the state where the customer is located. Allocation under the cost of performance method would be to the location where the service is primarily performed. If it is a personal service, the allocation could be to multiple jurisdictions, based on the time spent performing services in those jurisdictions for that particular sale.

For 2011 and 2012, California had a three-factor formula, as previously mentioned; it also allowed an option to use a single sales factor. The market-based approach was required only if a corporation chose to use the single sales factor. For 2013, because California now requires the use of the single sales factor for most corporations, the market-based approach is also required to allocate income from services. In contrast, New York State requires allocation of service income under the cost of performance method.

This creates some interesting allocation results.

For example, if a California company performs a service in California (e.g., creates an architectural design) and sells it (not TPP) to a New York company for its use, this would not be a California sale under the market-based approach. Prior to California’s new rules, this sale would have been thrown back to California if the seller had no physical connection to New York; thus, it would have become a California sale because the company does not have nexus in New York and is not taxable there. Under the new rules, if such sales are greater than $500,000 (subject to annual increases for inflation), they will not be thrown back to California because they would be taxable in New York (even if they are not actually taxed in New York). Therefore, this income would escape California allocation and, of course, New York allocation, because there is no filing requirement. Public Law 86-272 is not an issue because it does not apply to sales of other than TPP [see 15 USC section 381(a)(1)]. This is explained in CCR 2012-03:

In determining the $500,000 sales threshold …

Here, the taxpayer represents that using the rules contained in Section 25136(b) and Regulation 25136-2, its sales of other-than-TPP are properly assigned to states other than California, based on its own analysis of its books and records. Assuming this is true, ******* is considered taxable for purposes of Section 25122 in those states where it has greater than $500,000 in sales.

Further Considerations

One interesting point is that if this fictitious company files a combined report with another California company that sells goods (TPP) to New York, those sales will also escape the California throwback rules, because if one company in a combined report is taxable in another state, then all companies in the combined report are deemed to be taxable in the other state; therefore, there is no throwback. But this does not mean that a single corporation with sales of TPP to another state outside California would escape the throwback rule if the company has sales greater than $500,000 to that state. It only applies in the case where they file a combined report with a company that is subject to tax in the other state. This was also covered in CCR 2012-03:

Because (combined company A) is taxable in the other states and its activities are not protected under P.L. 86-272, and because (combined company A) and (combined company B) are members of the same combined reporting group, pursuant to Section 25135(b)(2), (combined company B) is not required to throw back interstate sales to its California sales factor numerator. [Company A and B inserted for clarification]

Another interesting point about service income allocation is that if the example above is reversed, and a New York corporation performs a service in New York and sells it to California, the New York corporation will allocate the sale to New York because that state’s allocation is based on location of the service (cost of performance method). The company will also have to file a California return because of the economic nexus rules and allocate that sale to California, because California allocation is based on beneficial use of the customer (market-based approach). The income is allocated to both states. Tax advisors and their clients should use these examples as food for thought when planning their tax strategy.

Brian Gordon, CPABrian Gordon, CPA, is the Director of State and Local Taxes at Sanders Thaler Viola & Katz LLP, a CPA and advisory firm with offices in Jericho, N.Y., and New York, N.Y. Previously, he was with the NYS Department of Taxation and Finance as the District Audit Manager in Manhattan and Brooklyn. He is a member of the NYSSCPA’s New York, Multistate & Local Taxation Committee and writes and speaks on various tax issues. He can be reached at 516-704-7130 or 516-510-6041, and by email at He posts a monthly blog at

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