Key Takeaways
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States are rethinking tax policy and revenue sources
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The digital economy continues moving into the tax base
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Sourcing and apportionment disputes continue to drive SALT litigation
The third quarter reinforced a trend we’ve been watching all year: states continue to pursue tax competitiveness while simultaneously searching for new sources of revenue. As income tax reductions and property tax relief gain momentum in many jurisdictions, legislatures, revenue departments, and courts are increasingly focused on expanding tax bases, narrowing deductions, revisiting incentives, and adopting aggressive sourcing positions.
From digital advertising taxes and software taxation to sourcing disputes and apportionment challenges, recent state tax developments reveal a common theme: states are redefining how and where tax revenue is generated.
Tax Policy Is on the Ballot
Tax policy has become a centerpiece of state elections and ballot initiatives. Across the country, voters and policymakers are debating whether governments should rely more heavily on income taxes, property taxes, sales taxes, or emerging revenue sources.
Iowa continues to lead the property tax relief movement, recently enacting what has been described as one of the largest property tax reduction measures in the country. At the same time, Iowa voters will decide whether future income tax increases should require a legislative supermajority.
Colorado voters will consider whether to return to a graduated income tax system after decades of a flat tax structure, while Missouri voters overwhelmingly rejected a proposal that would have phased out the state’s income tax and expanded sales tax instead.
These debates are occurring alongside renewed scrutiny of data center incentives and other economic development programs. Regardless of party affiliation, many candidates are campaigning on tax reduction proposals, particularly income tax and property tax relief. The question for taxpayers is not whether states will need revenue, but where they will look to replace it.
The Digital Economy Continues Moving Into the Tax Base
As states search for revenue, digital products and services remain a primary focus.
The most visible example is the ongoing battle over digital advertising taxes. Maryland’s digital advertising tax suffered significant losses in court, but appeals continue, while Utah and Illinois move forward with their own versions of digital advertising taxes. Litigation challenging those taxes has already begun.
See related: Digital Advertising Taxes: Gross Receipts, Sales Tax, or Fees?
Beyond digital advertising, states continue expanding the taxation of software, SaaS, and digital products. California is preparing to tax prewritten software and SaaS beginning in 2027. New York recently upheld taxation of a cloud-based document management platform as taxable software, and Arkansas issued additional guidance on the taxability of digital subscriptions and digital media.
See related: California Is Expanding Sales Tax to Digital Products and Software
The common thread is clear: as businesses and consumers become increasingly digital, states are looking to modernize tax systems and capture revenue from economic activity that did not exist when many tax laws were originally written.
Sourcing Disputes Continue to Expand
Another major trend this quarter is the increasing number of sourcing disputes across jurisdictions.
Wisconsin recently drew attention with a significant software sourcing case involving a Massachusetts software company and a Wisconsin customer. In InterSystems v. Wisconsin Department of Revenue, the court rejected a look-through sourcing approach and instead sourced receipts based on the taxpayer’s direct customer. The result was a substantial Wisconsin tax liability tied to revenue earned from the software license agreement.
In Texas, cities and the Comptroller are still fighting over sales tax sourcing rules and whether fulfillment centers and other locations constitutes a place of business for sourcing purposes.
Texas Appeals Court Blasts Comptroller on Sales Tax-Sharing Rule – Perry Cooper, Bloomberg Tax ($):
Recent California OTA decisions on severance payments and partnership gains have further redefined the state's sourcing rules. These rulings reinforce the importance of properly characterizing income and determining where value is actually created.
As states increasingly adopt market-based sourcing and economic nexus standards, taxpayers should expect sourcing controversies to remain one of the most active areas of SALT litigation.
Courts Are Reexamining Apportionment
Apportionment also remained a major theme during the quarter.
In Apple v. Nebraska Department of Revenue, a Nebraska court held that alternative apportionment was appropriate for Apple’s one-time Section 965 transition income tax, but rejected both Apple’s and the state’s proposed methodologies because neither produced equitable apportionment. The decision highlights the difficulty states face when applying traditional apportionment formulas to unusual or nonrecurring income streams.
California also issued decisions involving unitary business principles, including the Watts and Western Distributing cases, while Massachusetts and New Hampshire courts addressed combined reporting, apportionment, and group-level tax calculations.
New Hampshire High Court Overturns Capital Loss Carryback Ruling – Evan Conner, Tax Notes ($):
Together, these cases demonstrate that courts remain willing to scrutinize whether standard formulas accurately reflect economic reality.
What Taxpayers Should Be Watching
The quarter’s developments point to several recurring themes: states are reconsidering how government should be funded, expanding taxation of digital activity, aggressively pursuing sourcing issues, and continuing to test the limits of existing apportionment frameworks.
While the specific issues vary by state, the broader trend is consistent. States are not simply raising tax rates. Instead, they are redefining how income is sourced, how digital activity is taxed, and how tax revenue is generated in an increasingly modern economy.
