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January 17, 2013 The Tax Lawyer

Whirlpool Properties, Inc. v. Director, Division of Taxation: The Throwout Rule Should Be Thrown Out

Vol. 65, No. 4 - Summer 2012

Bernadette DiPrisco


    Over the past century, as businesses have evolved from serving the communities in which they were physically located to becoming national corporations, states have struggled to claim their fair share of the proceeds through corporate taxation. Historically, businesses dealt with apportioning income to individual states by maintaining separate accounting records for activity in each state. However, with the increased modernization of business function, simple geographical apportionment of income became impractical. As an alternative, many states have adopted statutory formulas as a method of apportioning income. These formulas generally use a three-factor approach, comparing a taxpayer’s in-state payroll, property, and sales receipts to those payrolls, property, and sales receipts outside the state. New Jersey is a state that uses such a formula. A particularly controversial element of the analysis under that formula is known as the “throwout rule.”

    In Whirlpool Properties, Inc. v. Director, Division of Taxation, the New Jersey Supreme Court held that the throwout rule, when interpreted narrowly, was facially constitutional as a means of determining tax liability in New Jersey. This was a modification of the appellate court’s holding, which had allowed for a broad reading and application of the rule that ultimately rendered it unconstitutional. The state supreme court drew a distinction between excluding receipts from states that did not have jurisdiction to tax a particular business and excluding receipts from states that opted not to impose such a tax, holding that the former action was constitutional but the latter was not.

    This Note will argue that the New Jersey Supreme Court failed in its analysis of the throwout rule because neither form of excluding receipts is constitutional. Part II provides an overview of how tax liability is determined for corporations in New Jersey as well as the constitutional requirements of state taxation under the Commerce and Due Process Clauses. Part III summarizes the procedural history and the New Jersey Supreme Court’s opinion in the Whirlpool case. Part IV.A argues that the court used the correct standard in its analysis. Part IV.B describes how the court’s analysis of the throwout rule was incomplete and contends that the court should have invalidated the rule instead of narrowing it.

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