Is a merger termination fee business income in California, and does it belong in the sales factor?
Edvin Givargis Published 6 minute read
The short answer
Usually yes to the first question and usually no to the second, and the combination is what surprises people. A termination fee received when a merger or acquisition falls apart is apportionable business income under California's transactional test when deal-making is a regular part of the taxpayer's business, which is how the court of appeal treated a 1.5 billion dollar breakup fee in the Comcast litigation. But inclusion in the tax base does not carry the receipt into the sales factor. Under the occasional sale rule of Regulation 25137(c)(1)(A), gross receipts from an occasional transaction outside the normal course of business are excluded from the sales factor when they are substantial, meaning their exclusion would decrease the sales factor denominator by five percent or more. A fee large enough to matter is usually large enough to be substantial, so the ordinary result is a receipt that is taxed and apportioned with the rest of the year's income but distorts neither factor.
The base question: business income under the transactional test
California defines business income as income arising from transactions and activity in the regular course of the taxpayer's trade or business, along with income from property whose acquisition, management, and disposition constitute integral parts of the taxpayer's regular operations (RTC 25120(a)). The two clauses are read as independent tests, transactional and functional, and either one makes the income apportionable.
A merger termination fee looks at first like the opposite of regular course activity: it is a one time payment, triggered by a deal that did not happen, under a liquidated damages provision rather than a sale of anything. The court of appeal confronted exactly that argument in the Comcast litigation and held the fee to be business income under the transactional test, reasoning that the taxpayer regularly engaged in mergers and acquisitions, so a payment arising from the collapse of one such transaction arose from the regular course of its business even though the specific event was singular (ComCon Production Services v. Franchise Tax Board (2016)). The frequency of the payment is not the question; the question is whether the activity that generated it, here the ongoing program of acquiring and combining businesses, is part of how the enterprise operates. For a company whose growth runs through acquisitions, a breakup fee is the income of a deal program, and deal programs are business.
The classification matters because business income is apportioned to every state where the recipient files, while nonbusiness income is allocated, typically to the commercial domicile for an intangible receipt of this kind. A taxpayer domiciled outside California generally prefers nonbusiness treatment for a large fee; the transactional test, as applied to serial acquirers, generally forecloses it.
The factor question: the occasional sale rule
Once the fee is in the apportionable base, the instinct is to put the receipt in the sales factor, gross receipts being gross receipts. California's special industries and special circumstances regulation interrupts that instinct. Where substantial amounts of gross receipts arise from an occasional sale of a fixed asset or other property held or used in the regular course of the taxpayer's trade or business, those receipts are excluded from the sales factor (Cal. Code Regs. tit. 18, ยง 25137(c)(1)(A)). The regulation supplies both operative definitions. A sale is occasional if the transaction is outside the taxpayer's normal course of business and occurs infrequently. A sale is substantial if its exclusion results in a five percent or greater decrease in the sales factor denominator, tested for the combined reporting group where one exists, with receipts from the same purchaser in a single year aggregated.
The arithmetic is mechanical and should be run before anything is concluded. A group with a thirteen billion dollar denominator receiving a fee approaching two billion dollars is far past the line: the fee would be more than a tenth of the potential denominator, and its exclusion would decrease the denominator well beyond five percent. The occasional element is equally straightforward on such facts, since even a serial acquirer does not regularly collect breakup fees; the deal program is regular, the collapse payments are not. That distinction is precisely why the base answer and the factor answer differ without contradiction: the transactional test asks whether the generating activity is regular, while the occasional sale rule asks whether the receipt is, and a regular activity can throw off an irregular receipt.
One application question deserves honesty. The regulation speaks of an occasional sale of a fixed asset or other property, and a termination fee is not literally the sale of anything; it arrives under a contract provision, not a transfer of property. The regulation's own examples, though, run from factories to patents to stock of an affiliate, and its purpose is distortion control: a large, unusual gross receipt inflates the denominator and dilutes the California percentage without any corresponding California activity, whatever its doctrinal label. The considered position, consistent with how the exclusion has been applied in practice, is that a substantial, occasional receipt of this character falls within the rule, and it is worth noting that in the Comcast litigation it was the Franchise Tax Board itself that excluded the termination fee from the sales factor denominator. A taxpayer arguing for inclusion of a large fee in its denominator should expect to litigate against both the regulation and the agency's demonstrated position.
The procedural trap the case law adds
The Comcast litigation carries a second lesson that has nothing to do with substantive law. The taxpayer sought to challenge the exclusion of the fee from its sales factor denominator in court, and the court refused to hear the argument because the ground had not been raised in the refund claim. California's refund procedure limits the taxpayer to the grounds stated in the claim, so a computation position not preserved at the claim stage is gone regardless of its merits. For any year in which a large unusual receipt was reported, the refund claim should state every ground the taxpayer may want later: the character of the receipt, its inclusion or exclusion from the base, and its treatment in each factor, even the positions that seem secondary at filing.
Practice notes
The termination fee file has three schedules. First, the character memo: document the taxpayer's deal history, because the transactional test analysis rises or falls on whether acquisition activity is regular, and the record of transactions pursued, completed, and abandoned over the surrounding years is the evidence. A genuine one-off, a company that attempted a single transformative merger and never another, presents a different transactional test case than a serial acquirer, and the memo should say which one the facts support. Second, the substantiality computation: build the sales factor denominator with and without the fee, at the combined group level, aggregate same-purchaser receipts, and state the percentage against the five percent line, because the occasional sale exclusion is not elective and applies by its terms once its conditions are met. Third, the consistency check: the base treatment, the factor treatment, and the filings in other states should tell one coherent story about the same dollars, and where other states include the receipt in their factors, the multistate picture should be reconciled rather than left to surface on audit. And in any refund posture, plead everything: the claim drafted narrowly is the claim that forecloses the argument that turns out to matter.
This article states the law as of September 14, 2026
Statutes, rates, thresholds, and agency practice change, and a different set of facts can change the answer. Before acting on anything discussed above, contact G&G State Tax Group to confirm what has changed since this was written and how the rules apply to a specific situation.
G&G State Tax Group, LLC is a state and local tax advisory firm. The firm provides state and local tax consulting and representation in state and local tax controversies. G&G does not prepare or file tax returns, perform attest services, or provide bookkeeping, and is not a CPA firm.