The California throwback rule pulls certain out-of-state sales back into your California sales factor when the destination state cannot legally tax you. It lives in Revenue and Taxation Code Section 25135, and it applies when tangible goods ship from a California location to a buyer in a state where your company lacks tax nexus. Because California apportions corporate income using a single sales factor, every dollar thrown back directly raises the percentage of your income exposed to the 8.84% corporate franchise tax.1State of California Franchise Tax Board. Business Tax Rates
When the Rule Triggers
Section 25135(a) sources a sale of tangible personal property to California in two situations. The first is the ordinary destination rule: goods delivered or shipped to a California purchaser count as California sales. The second is the throwback provision: goods shipped from a California office, warehouse, factory, or other storage location count as California sales when either the purchaser is the U.S. government or the seller is not taxable in the state where the buyer is located.2California Legislative Information. California Revenue and Taxation Code Section 25135
Two conditions must both be true. The property must ship from a California location, and the seller must not be taxable in the destination state. Miss either one and throwback does not apply. Goods shipped from a Nevada warehouse into a non-nexus state stay out of California’s numerator. Goods shipped from California into a state where you do have nexus stay assigned to that state under normal destination sourcing.
What “Not Taxable in Another State” Means
The definition of “taxable” is broader than most companies expect. Under R&TC Section 25122, you are taxable in another state if either of two tests is met. First, you are actually subject to that state’s net income tax, franchise tax measured by net income, franchise tax for the privilege of doing business, or corporate stock tax. Second, that state has the legal jurisdiction to impose a net income tax on you, whether or not it actually does.3California Legislative Information. California Revenue and Taxation Code Section 25122
The jurisdiction test is what matters in most planning. You do not have to file a return or pay tax in the destination state. If that state could legally tax you based on your activities there, California treats you as taxable there and throwback does not apply. The reverse also holds: if the destination state lacks the power to tax you, the sale gets thrown back even if you voluntarily filed there or paid some other tax that does not qualify under Section 25122.
Why Public Law 86-272 Is the Usual Culprit
The most common reason a company is “not taxable” in a destination state is federal protection under Public Law 86-272. That statute bars a state from imposing a net income tax on an out-of-state seller whose only in-state activity is soliciting orders for tangible personal property, provided those orders are approved outside the state and filled by shipment from outside the state.4Office of the Law Revision Counsel. 15 USC 381 – Imposition of Net Income Tax If your only presence in a destination state is salespeople taking orders, P.L. 86-272 shields you from that state’s income tax. The same shield is what triggers California throwback, because the destination state cannot tax you.
The federal protection is narrow. It covers only tangible personal property, so services, software licenses, and other intangibles do not qualify. And it evaporates the moment your employees do anything beyond solicitation in the destination state, such as installing products, providing technical support, or performing warranty repairs.5Multistate Tax Commission. Statement of Information Concerning Practices of Multistate Tax Commission and Signatory States Under Public Law 86-272
Internet Activities Are a Live Fight
Whether common online activities exceed P.L. 86-272 protection is unsettled. The Multistate Tax Commission’s revised 2021 statement takes the position that “virtual contacts” with a state’s residents can be business activities beyond mere solicitation, citing the Supreme Court’s reasoning in South Dakota v. Wayfair.6Multistate Tax Commission. Statement of Information Concerning Practices of Multistate Tax Commission and Supporting States Under Public Law 86-272 California’s own guidance, Technical Advice Memorandum 2022-01, listed nine internet activities the Franchise Tax Board considered unprotected. A San Francisco Superior Court struck down the TAM in December 2023, finding it was an “underground regulation” adopted without following the Administrative Procedure Act.7Ernst & Young. California Superior Court Finds FTBs PL 86-272 TAM and Publication to Be Invalid Underground Regulations The guidance is technically invalid, but reports indicate FTB auditors continue applying its principles on exam. If you rely on P.L. 86-272 in states where you have significant online customer interactions, expect scrutiny that can flip sales into the throwback bucket.
Combined Groups and the Finnigan Rule
Many California corporate taxpayers file as part of a combined reporting group. That raises the question of what happens when the selling entity lacks nexus in the destination state but a sister company in the group has it.
For tax years beginning on or after January 1, 2011, California applies the Finnigan rule, codified in R&TC Section 25135(b). The analysis looks at the entire combined group rather than the single member that made the sale. If any member of the group is taxable in the destination state, the sale stays assigned there and does not get thrown back. Throwback applies only when no member of the group is taxable in the purchaser’s state.2California Legislative Information. California Revenue and Taxation Code Section 25135 For groups with diverse operations, this often eliminates throwback exposure that would have existed under prior rules.
Double Throwback for Drop Shipments
A more aggressive version of the rule applies when goods never pass through the seller’s own facilities. Say your California sales office directs a third-party manufacturer in Colorado to ship products directly to a customer in Arizona. The goods were never in California. Under the ordinary throwback rule, if you lack nexus in Arizona, the sale would be thrown back to Colorado as the state of shipment. If you also lack nexus in Colorado, the sale has nowhere to land. California’s regulation then throws the sale all the way back to California as the state where the sales activity originated. This is the “double throwback” rule.8Franchise Tax Board. Multistate Audit Technical Manual Chapter 7500 – Sales Factor
What Throwback Does Not Cover
Section 25135 applies only to sales of tangible personal property. Revenue from services and intangibles follows market-based sourcing under R&TC Section 25136: service revenue goes to the state where the customer receives the benefit, and revenue from intangibles goes to the state where the property is used.9Legal Information Institute. California Code of Regulations Title 18 Section 25136-2 There is no throwback concept in that framework. If your California company earns consulting fees from a Texas client, that revenue is assigned to Texas regardless of whether you have nexus there. Service businesses and software companies generally escape throwback; manufacturers and distributors of physical goods bear the full weight of it.
What Throwback Costs You
Most California corporations apportion income using a single sales factor: California sales divided by total sales everywhere. That fraction is multiplied by total apportionable business income to determine what is taxable in California.10California Legislative Information. California Code RTC 25134 Throwback grows the numerator without changing the denominator.
A simplified example:
- Total sales everywhere: $10,000,000
- Sales delivered to California customers: $3,000,000
- Sales shipped from California to states where no group member is taxable: $2,000,000
- Total apportionable business income: $5,000,000
Without throwback, the California sales factor is $3,000,000 / $10,000,000 = 30%. Income taxable in California: $1,500,000. Tax at 8.84%: $132,600.
With throwback, the $2,000,000 in non-nexus sales joins the California numerator: ($3,000,000 + $2,000,000) / $10,000,000 = 50%. Income taxable in California: $2,500,000. Tax at 8.84%: $221,000. That is $88,400 in additional California tax attributable to throwback alone. The effect scales with how much you ship from California into states where you lack nexus, and for a company that manufactures in California and ships nationwide with minimal out-of-state presence, throwback can push the apportionment factor well above what pure destination sourcing would produce.
Reducing Your Exposure
Companies with material throwback exposure generally consider a few options.
The most direct is establishing nexus in destination states so the “not taxable” condition is no longer met. Voluntarily subjecting yourself to another state’s income tax sounds counterproductive, but if that state’s rate is lower than California’s 8.84%, the trade can come out ahead. Some states also allow voluntary nexus elections.
Another approach is shipping from a location outside California. Because the throwback rule requires shipment from a California location, moving distribution to a warehouse in Nevada, Texas, or elsewhere takes those sales out of Section 25135 entirely. The Tax Foundation has documented companies relocating distribution operations out of throwback states for exactly this reason.11Tax Foundation. State Throwback Rules and Throwout Rules: A Primer The math has to weigh tax savings against the real cost of running warehouses in multiple states.
Combined reporting groups have a structural option under Finnigan. Because throwback only bites when no group member is taxable in the destination state, expanding any one member’s activities in a destination state enough to create nexus can eliminate throwback for every member shipping there.2California Legislative Information. California Revenue and Taxation Code Section 25135 The group’s overall nexus footprint becomes the planning variable, not just the footprint of the entity making the sale.