Massachusetts Rules the “Finnigan” Sales-Factor Adjustment Unconstitutional

In Smithfield Packaged Meats Corp. & Combined Affiliates v. Commissioner of Revenue, the Massachusetts Appellate Tax Board invalidated the state’s “Finnigan” sales-factor adjustment as applied to a corporation protected by Public Law 86-272. The Board held that reassigning a protected corporation’s Massachusetts sales into the group’s apportionment numerator effectively taxes income that federal law places beyond the state’s reach, violating the Supremacy Clause of the U.S. Constitution.

The decision is significant because it rejects a Finnigan approach that several other states have adopted and may create refund opportunities for combined groups that include members protected by Public Law 86-272.

Facts About the Case

Smithfield Packaged Meats Corp. and its combined affiliates filed Massachusetts combined returns for the 2015 through 2017 tax years. The group operated through a vertically integrated structure in which certain affiliates manufactured pork products and related goods, while separate sales affiliates distributed those products to customers.

Upon review, the Commissioner made several adjustments and assessments that the taxpayer challenged.

The case addresses four primary issues, including the classification of certain sales affiliates as manufacturers, the assessment of underpayment penalties, procedural questions relating to the validity of the assessments, and the application of Massachusetts’ Reallocation Rule in conjunction with Public Law 86-272. This article focuses on the latter issue because of its potentially broad implications for multistate taxpayers.

Background: Joyce, Finnigan, and Public Law 86-272

Public Law 86-272 is a federal law that prohibits a state from taxing a company’s income when its only activity in that state is soliciting orders for tangible goods approved and shipped from outside the state.

When a unitary group files as a combined group that includes a member protected by P.L. 86-272, states are divided on whether that member’s in-state sales should be included in the group’s apportionment numerator.

• Under the Joyce approach, only member sales that are themselves taxable in the state are included in the numerator. Accordingly, sales by a Public Law 86-272 protected member are excluded.
• Under the Finnigan approach, the combined group is treated as a single taxpayer. If any group member has nexus with the state, all in-state sales of the combined group may be included in the numerator, including sales generated by a member protected under Public Law 86-272.

The difference can have a substantial impact on a taxpayer's apportionment percentage and resulting state tax liability. Some states, including California, follow a Finnigan approach, while others continue to apply Joyce. Massachusetts adopted a Finnigan-style methodology through its Reallocation Rule, which became the focus of the dispute in Smithfield.

The Finnigan Adjustment Struck Down

For 2017, one member of the combined group, Fresh Meat Sales, was protected by Public Law 86-272 because its only Massachusetts activity consisted of soliciting orders, with no property or employees in the state.

Despite that federal protection, the Commissioner applied the Massachusetts’ Finnigan Reallocation Rule and shifted approximately $85.7 million of the protected member’s Massachusetts sales into the taxable member’s sales-factor numerators.

In other words, Massachusetts attempted to reach sales that would have remained outside the state's taxing jurisdiction if the protected entity had been viewed on a standalone basis.

The Board agreed with the taxpayer, holding that the adjustment violated the Supremacy Clause because Public Law 86-272 preempts states from taxing income derived from protected activities. Specifically, the Board reasoned that:

• The term “person” in Public Law 86-272 refers to an individual entity, not an entire unitary group.
• P.L. 86-272 protects the income generated by the protected entity, not merely the entity itself, so it does not matter whose return that income is reported.
• A state cannot do indirectly through apportionment what federal law prohibits it from doing directly.

Accordingly, the Board concluded that Massachusetts could not include the protected member's Massachusetts sales in the apportionment numerator of other combined group members, rejecting contrary decisions from Arizona, New York, and California.

Why the Decision Matters

The ruling creates a significant split with jurisdictions that have upheld Finnigan-style approaches when a combined group includes a member protected by Public Law 86-272.

For Massachusetts taxpayers, the decision may affect ongoing tax audits, open tax years, and potential refund opportunities where protected member sales were included in the apportionment numerator under the Reallocation Rule. In Smithfield itself, removing the Finnigan adjustment produced a $239,719 abatement for the 2017 tax year and eliminated the underpayment penalty for that year.

More broadly, the case provides support for future challenges to Finnigan methodologies in other states where taxpayers believe Public Law 86-272-protected sales have been indirectly subjected to tax through combined-reporting rules.

Our State and Local Tax team can help evaluate the potential impacts of this decision.