California Financial Institutions Now Subject to Single Sales Factor Apportionment

On June 27, 2025, Gov. Gavin Newsom signed S.B. 132 into law, resulting in significant changes in how banks and other financial entities apportion their income to California. The bill revises Revenue & Taxation Code (R&TC) section 25128 by removing “savings and loan activity” and “banking or financial business activity” from the definition of a “qualified business activity” effective for tax years beginning on or after Jan. 1, 2025. As a result, banks and financial corporations (collectively, “financial institutions”) will now be required to utilize a single sales factor instead of an equally weighted three-factor formula consisting of payroll, property, and sales. The Senate committee estimates that requiring financial institutions to adopt a single sales factor will result in additional revenue for the state of over $1.1 billion over a five-year period (fiscal years 2025-2029).

While S.B. 132 will surely raise revenue for California, did the legislature strike gold for the Golden State, or did they open Pandora’s box?

Under R&TC sections 23182, 23183, and 23186, California imposes an additional 2% corporate income/franchise tax on financial institutions in lieu of many other taxes, licenses, and fees, including local business taxes such as the Los Angeles Business Tax and the San Francisco Gross Receipts Tax. Therefore, banks and financial institutions can avoid many state and local taxes and fees, but at the cost of a higher income tax. The history of this approach is rather complex, but in simple terms, for many years the federal government (pursuant to 12 U.S.C. Section 548) restricted how states could tax national banks. In response, California adopted this “in lieu of” approach over the years. In reviewing the legislative history, the California Legislature stated:

“…taxation of banks and financial corporations at the rate determined under Revenue and Taxation Code section 23186 insures that their tax burden will be comparable to the combined state and local tax burdens of nonfinancial corporations subject to Revenue and Taxation Code section 23151.”

In other words, the additional 2% income tax imposed on financial institutions (making their state income tax rate 10.84% instead of the 8.84% imposed on other corporations) is intended to put financial institutions on equal footing with general corporations, given the historical federal and state restrictions on how banks could be taxed.

As a result of S.B. 132, non-California-based financial institutions doing business in the state, but not owning property or employing personnel there, might expect to see a significant increase in their California income tax. While such financial institutions continue to be taxed at the higher 10.84% rate, something seems inherently unfair if these entities generally receive no or limited benefits of the “in lieu of” provision under R&TC 23182. Under the Commerce Clause of the U.S. Constitution, it is a well settled principle that a state may not tax a transaction more heavily when it crosses state lines than when the transaction occurs entirely within the state. Does California violate the Commerce Clause by requiring out-of-state financial institutions to utilize a single sales factor while subjecting them to higher tax rates?

In Armco, Inc. v. Hardesty, 467 U.S. 638 (1984), the U.S. Supreme Court found that West Virginia’s imposition of a gross receipts tax on businesses selling tangible personal property at wholesale was unconstitutional. West Virginia imposed a gross receipts tax on wholesale sales but exempted local manufacturers from the tax. The exemption, however, subjected local manufacturers to a higher manufacturing tax. Armco, Inc., an Ohio-based corporation, objected to the wholesale gross receipts tax on the grounds that the tax discriminated against interstate commerce.

The Court agreed with Armco that the tax was unconstitutional for three reasons:

• The Commerce Clause prevents a state from taxing a transaction or incident more heavily when it crosses state lines than when it occurs entirely within the state. Exempting in-state manufacturers from the wholesale tax violates the Commerce Clause because it favors in-state manufacturers over out-of-state manufacturers.
• The wholesale tax cannot be deemed a “compensating tax.” Manufacturing activities and wholesale activities are not “substantially equivalent events” that would justify the imposition of a higher manufacturing tax in lieu of a wholesale tax.
• When the manufacturing and wholesaling taxes are viewed together, discrimination against interstate commerce persists, since any state outside West Virginia could impose a similar tax on manufacturers. The Court states, “[a]ppellant need not prove actual discriminatory impact on it by pointing to a State that imposes a manufacturing tax that results in a total burden higher than that imposed on in-state manufacturers. Any other rule would mean that the constitutionality of West Virginia’s tax laws would depend on the shifting complexities of the 49 other States’ tax laws, and that the validity of the taxes imposed on each taxpayer would depend on the particular other States in which it operated.”

With the removal of the payroll and property factors for tax years beginning on Jan. 1, 2025, could a Commerce Clause defense (similar to the argument raised by Armco) be utilized by out-of-state financial institutions that are subjected to a higher 10.84% tax rate? 

Contact a CBIZ SALT professional to discuss your specific facts and how you can prepare for California taxation under the single sales factor regime.