Apportionment of Service Revenue Can Produce Unusual Results

Merrill Barter, Tax Director
January 2016

In a previous article published in January 2014, we provided an overview of the revenue apportionment rules applicable to service businesses with filing requirements in multiple states. Some examples of businesses that may be impacted by these rules are law, accounting, architectural, and engineering firms – each of which may provide services and/or have clients in multiple states. This article is meant to be a “refresher” and to provide information related to a few specific states.

Methods of apportionment

Service revenue apportionment generally is calculated in one of three ways - using the “Costs of Performance” method (COP), based on the actual work performed (AWP) within the state, or using the “Market Based” approach (MB). These apportionment methods typically are used for all business entities – C corporations, S corporations and partnerships (LLCs).


Under the COP method, 100% of the revenue from an income producing activity (IPA) is sourced to the state in which a greater proportion of the IPA was performed than in any other state. This doesn’t mean the majority (> 50%) of the work was done in the state, it only means that more work was done there than was performed anywhere else.

Some questions that can arise when using the COP method are:

  • What is the IPA? For example, if an attorney in a law firm is drafting a complex will, is the IPA the completion of the document, or is each hour of work in drafting the will a separate IPA?  Could each separate hour of work be billed to the client, or is the creation of the will a fixed-fee engagement?
  • Continuing with the example above, if the firm preparing the will has offices in Maine, New Hampshire and Massachusetts, and some of the work is performed in each of the offices, how should the revenue be apportioned?  Does the business have a process in place to track the work done and related revenue?


Under the AWP method, service revenue is apportioned to a state based on the actual work done in that state. A very simplistic example would be an accounting firm that has a client in Connecticut, which uses this method, completes a project that took 100 hours, with a total fee of $15,000 ($150/hour). If 30 hours of work was actually done in Connecticut, then $4,500 of the revenue attributable to the project would be sourced to the State.


The MB approach for sourcing service revenue sources receipts from the performance of services to the state where the benefits of the services are received – often the customer’s location. This seems simple, but as discussed in the previous article, there are complexities that can arise. One of the most common is, where are the benefits of the services actually received? For example, if a business consultant completes a project for a client that has multiple locations in states that use the MB approach, and the implementation of the consultant’s recommendations impacts multiple locations, where should the revenue be sourced?

State-specific methods and examples

For tax years beginning on or after January 1, 2015, 21 states will use the COP method, including New Hampshire and Vermont; seven states use the AWP method, including Connecticut and New Jersey; and 18 states use the MB approach, including Maine, Massachusetts, Rhode Island and New York. Massachusetts is unique, in that it has a “throw-out” rule. Receipts attributable to states in which the business does not have nexus (does not file, or would not be required to file), or for which the state to which the revenue should be attributed cannot be determined, are thrown-out of the denominator when computing the Massachusetts sales apportionment. This will drive-up the Massachusetts apportionment.

Due to the states’ varying apportionment rules, apportionment can vary depending on where the work is done and the clients are located, and results can be unfavorable. The following examples illustrate this.

  1. Engineering Firm (EF) has offices in Massachusetts, New Hampshire and Connecticut, and performs a large project for a client located in New York. EF is required to and does file in all but New York. 30% of the work (based on hours) is done in Connecticut, 30% is done in Massachusetts, and 40% is done New Hampshire. As noted above, Connecticut apportions service revenue using the AWP method, Massachusetts and New York use the MB approach, and New Hampshire uses COP. Assume that the completed project is the “income producing activity” for the COP calculation. Using these facts:
    1. 30% of the revenue would be apportioned to Connecticut
    2. 100% of the revenue would be apportioned to New Hampshire
    3. As EF doesn’t file in New York, 100% of the revenue would be excluded from the numerator and denominator when computing the Massachusetts sales apportionment.

    The result is that far more than 100% of the income attributable to this job will be subject to tax – a very curious and unfavorable result!

  2. EF does a project for a client located in New Hampshire. This time, 55% of the work is done in Massachusetts and 45% is done in New Hampshire. Under these facts, none of the revenue would be sourced to any of the states – an equally curious but favorable result!

State’ sourcing of service revenue is not the only way their varying apportionment methodologies create unusual results. Some states, such as Connecticut, Maine, New York and Rhode Island, use only the sales factor. Others, like Massachusetts, New Hampshire and Vermont, use a 3-factor formula (sales, payroll and property). This can result in widely varying results depending on the location of the service provider and client.

The sourcing rules related to service revenue are complex, and vary depending on the type of work being done, where it’s being done, the types of customers being served, and the locations of the customers. This article and the examples used are meant to provide a high-level overview of the sourcing rules and related considerations. Please contact Merrill Barter or your BNN tax advisor at 1.800.244.7444 for assistance applying these rules to your specific circumstances.

Disclaimer of Liability: This publication is intended to provide general information to our clients and friends. It does not constitute accounting, tax, or legal advice; nor is it intended to convey a thorough treatment of the subject matter.