Difference Between Allocation & Apportionment

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Business accountant using calculator at desk.
Business accountant using calculator at desk. (Image: Alliance/iStock/Getty Images)

When a business earns a profit, it typically must pay both state and federal income tax. Many businesses earn income in more than one state. To determine how much of a business's income is taxable in each state, the state in which the business is headquartered uses the procedures of allocation and apportionment.

Defining Allocation and Apportionment

Allocation is a process a state tax department uses to assign all of a certain type of taxable income to one or more specific states. Apportionment, on the other hand, is a process that a state tax department uses to divide certain types of taxable income among several states based on a formula that considers payroll, sales and the location of the business property.

Comparison

While apportionment involves the use of mathematical formulas to determine what proportion of income is taxable in each state, allocation assigns all income to one state or divides it evenly between multiple states. A state tax department uses allocation to assign a business entity's non-business income to certain states, but it uses apportionment to distribute a business entity's business-related income among the states in which the business operates.

Business and Non-Business Income

To determine whether income is subject to apportionment or allocation, the state must first determine whether the income qualifies as business income or non-business income. Non-business income typically includes patent income, copyright royalties and certain capital gains, while business income typically includes any income related to the business's regular trade. Each state publishes its own rules for determining what types of income qualify as business or non-business income.

Considerations

If a state tax department allocates non-business income to a state in which the business is exempt from taxation, the income is taxable in the business's home state instead. Though state tax departments typically classify passive income as non-business income, passive income may qualify as business income if it constitutes an integral part of the business's primary trade. For example, if a company's primary function involves purchasing copyrights for profit, the income generated by the copyrights is business income.

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