Learn more about the throwback rule, how it works, and its pros and cons.
Definition and Examples of a Throwback Rule
States can adopt the “throwback rule” to ensure that corporations pay taxes on 100% of their sales, including destination states in which that corporation does not have a physical nexus. Examples of a nexus include an office or warehouse with delivery trucks. Ordinarily, sales in destination states in which the business has no nexus are not subject to taxes. If a state enforces the throwback rule, those sales would be “thrown back” to the origin state and subject to that state’s tax laws. Consider this example: Company ABC is headquartered in California, which enforces the throwback rule. Sales conducted in California are subject to California’s tax policies. Company ABC also has sales in Maryland but does not have a nexus in that state. Since there is no nexus, Maryland has no jurisdiction to impose a tax. Under the throwback rule, these sales are thrown back to California and taxed accordingly.
How Does a Throwback Rule Work?
Under Public Law (PL) 86-272, the state cannot impose a net income tax on sales of tangible goods in a destination state if the business only solicits the orders and then fulfills those orders outside the destination state. This created an opportunity for businesses to generate “nowhere income,” where sales would not be subject to taxes in the origin state or destination state. Owners could create business models that focused on selling tangible goods across state lines that qualified for the tax protections under PL 86-272. Proponents of the throwback rule say the rule closes this tax loophole by ensuring that 100% of a corporation’s sales—nowhere income included—is subject to taxes. States can only tax corporations that have a nexus to the state. If a corporation sells within a destination state and has no nexus, it does not get taxed anywhere. Under the throwback rule, that nowhere income is “thrown back” to the origin state and subject to taxes. Not all states enforce a throwback rule and some states are undergoing discussions about using it. Maryland recently passed the throwback rule, which is scheduled to take effect on July 1, 2022.
Double Throwback Rule
The “double throwback rule” can apply when the taxpayer is not taxable in either the destination state or origin state. This typically occurs when a transaction has “contact” with three different states. For example, let’s say Business XYZ operates in California and is working with a manufacturer in Nevada. The salesperson tells the Nevada-based manufacturer to ship directly to the customer in Florida. There are three instances in which the sale can be taxed:
Pros and Cons of a Throwback Rule
Pros Explained
Levels the playing field: Larger corporations may have more resources to source sales in destination states without throwback rules. This gives larger corporations an unfair tax advantage compared to smaller businesses with sales sourced primarily within the state.Deters tax avoidance: Corporations may target destination states without creating a physical nexus to enjoy tax-free sales. Proponents of the throwback rule say the rule ensures that all business income is properly taxed.
Cons Explained
Violates economic neutrality: Opponents of the throwback rule say tax implications for sales in destination states should be uniform among all firms, regardless of the origin state. The throwback rule, however, would only apply to corporations in origin states with throwback rules.Potential loss of jobs: Enforcing a throwback rule may induce businesses to relocate to states that do not enforce it. Businesses that leave also bring jobs and income with them, which can make the rule counterproductive and harmful to working citizens.
