What happens when every apportionment factor is zero and a state imputes 100 percent?
Edvin Givargis Published 17 minute read
The short answer
A notice that treats an entity's income as 100 percent in-state because its apportionment factors are zero is usually a reading of the return, not of the law. In Illinois the operative test is the first sentence of Section 304(a) of the Illinois Income Tax Act: a nonresident's business income is allocated to Illinois in full only if it is derived solely from Illinois; income derived from Illinois and one or more other states is apportioned, and for tax years ending on or after December 31, 2000 the factor is the sales factor alone (35 ILCS 5/304(a), (h)(3)). The statute carries zero-denominator rules only for tax years ending before December 31, 2000 and says nothing about a single sales factor whose denominator is zero, and the Department of Revenue, answering an annual multistate tax questionnaire in 2021, answered that a factor with a zero denominator is not eliminated from the computation and that when the denominator is zero there is no business income to apportion to Illinois (IT 21-0008-GIL, October 1, 2021), the opposite of the notice. The remedy has two layers: show that the notice misreads the return, because the income is nonbusiness income, a distributive share already apportioned at a lower tier, or business income whose receipts the statute excludes from the factor; and, where a working percentage is needed, construct a denominator from the excluded receipts or other income streams and petition under Section 304(f), at least 120 days before the return is due or, for a year already filed, with an amended return (86 Ill. Adm. Code 100.3390(e)).
How a zero factor becomes 100 percent
The all-zero factor is a structural feature of holding and investment entities. Under the single sales factor, the numerator is sales in Illinois and the denominator is sales everywhere (35 ILCS 5/304(a)(3)(A)), and three kinds of income leave that fraction empty. Nonbusiness income is allocated under Section 303 and is not in the factor. For tax years ending on or after June 16, 2025, nonbusiness gain on the sale of an interest in a partnership, other than an investment partnership, or of S corporation stock is allocated to Illinois in proportion to the average of that entity's Illinois apportionment factor for the year of sale and the two preceding years (35 ILCS 5/303(b)(4)). The same act added the business income counterpart to the sales factor: for a sale or exchange of S corporation shares or of a partnership interest, other than an investment partnership, the sale is in Illinois if the pass-through entity was taxable in Illinois, and the amount attributable to Illinois is determined by the same three-year average of the entity's Illinois apportionment factor (35 ILCS 5/304(a)(3)(C-5)(iii)(a-5), added by P.A. 104-0006). For the holding entity that means a year in which it sells a lower-tier interest is not a zero-over-zero year: the net gain enters the denominator of its sales factor, and the numerator by the lower tier's three-year average Illinois factor, so the factor has a value in that year even if every other receipt is excluded. A distributive share of business income from a non-unitary partnership is apportioned at the lower tier: the partnership return carries one line for business income received from a non-unitary partnership and another for the portion the lower tier reported as apportionable to Illinois, so the upper tier's own factor never touches it (Form IL-1065 Instructions, Step 6). And the statute excludes dividends, Section 78 amounts, and Subpart F income from both numerator and denominator (35 ILCS 5/304(a)(3)(D)). This analysis assumes an entity that apportions under Section 304(a). A partnership that meets the investment partnership tests of 35 ILCS 5/1501(a)(11.5) is not subject to the replacement tax (35 ILCS 5/205), and its income distributable to nonresident partners is generally nonbusiness income allocated to the partner's state of residence (35 ILCS 5/305(c-5)); an entity that is a financial organization, a term that includes an investment company (35 ILCS 5/1501(a)(8)(A)), apportions under Section 304(c).
The form is where the trouble starts. The instructions direct the filer to check a box if all base income is derived inside Illinois and otherwise to complete the apportionment step: total sales everywhere on Line 40, sales inside Illinois on Line 41, and on Line 42 the quotient, which "cannot be greater than one or less than zero" (Form IL-1065 Instructions, Step 6). Zero divided by zero is not a number. The Department has published no explanation of how its return-correction process computes a factor from zeros on Lines 40 and 41, but notices of this kind have described the apportionment information as missing and reset the Illinois share to 100 percent, the checkbox result. This article treats that 100 percent as a processing default rather than a legal conclusion, because the notice cites no statute.
What the Illinois statute provides, and what it does not
Section 304(a) states the rule the notice implicitly applies and then limits it: business income of a nonresident is allocated to Illinois "if such person's business income is derived solely from this State," and income derived from Illinois and one or more other states is apportioned by the sales factor (35 ILCS 5/304(a), (h)(3)). A partnership's base income is allocated or apportioned under Article 3 in the same manner as any other nonresident's (35 ILCS 5/305(c)). An entity holding a limited partner interest in a venture operating in several states, or a portfolio managed from an office outside Illinois, does not derive its business income solely from Illinois, and its zero factor is evidence of where the income comes from, not a concession that it is all Illinois income.
The statute once answered the zero-denominator case. The closing paragraph of subsection (h) provides that for tax years ending on or after December 31, 1998 and before December 31, 2000, if the denominator of the payroll, property, or sales factor is zero, the weighted factor is divided by 100 percent minus the weight given to each factor with a zero denominator (35 ILCS 5/304(h)). The three-factor formula for tax years ending on or before December 30, 1998 likewise reduced its divisor for each factor with a zero denominator (35 ILCS 5/304(a)). Both are the conventional drop-the-factor rule, and both expired with the phase-in. For a single sales factor year the legislature left no instruction, and nothing in Section 304 converts a zero denominator into a 100 percent factor.
The Department has addressed the point only informally. In a general information letter answering an annual multistate corporate income tax questionnaire in 2021, under the question whether a factor with a zero denominator is eliminated from the computation, the Department wrote: "If the denominator is zero, then no business income to apportion to IL" (IT 21-0008-GIL, October 1, 2021). The Department marked No on the questionnaire's question whether a factor with a zero denominator is eliminated from the computation, and the sentence explains the consequence it drew: the factor stays, and with nothing in it there is no business income to apportion to Illinois, not all of it. A general information letter is not binding and does not state Department policy, as every such letter recites, but the statement cuts against imputation.
The two remedies
The first remedy is to correct the record. The response reconciles base income line by line: nonbusiness income and where Section 303 allocates it; business income from non-unitary partnerships and the Illinois portion each lower tier reported; and the entity's own business income, with the receipts behind it and the provision that excludes them from the factor. It then states the position: the business income is not derived solely from Illinois, so Section 304(a) requires apportionment; the statute prescribes no factor for a zero denominator; and the Department's informal statement is that nothing is left to apportion.
The second remedy is for the entity with meaningful business income of its own that needs a working percentage. Section 304(f) provides that if the standard provisions do not fairly represent the market for the person's goods, services, or other sources of business income, the person may petition for, or the Director may permit or require, separate accounting, the exclusion of one or more factors, the inclusion of one or more additional factors that will fairly represent the person's business activities or market in Illinois, or any other method to effectuate an equitable apportionment (35 ILCS 5/304(f)). A constructed denominator is an additional factor under paragraph (3) or another method under paragraph (4): a fraction built from the receipts the statute excluded, or the income streams the entity allocates by source, with the total as denominator and the Illinois portion under the sourcing rule that would have applied as numerator. The method is an approximation, but it reflects where the income arises, which is the statutory standard.
The regulation governs the petition, and its timing is unforgiving. The party seeking an alternative method must prove by clear and convincing evidence that the statutory formula attributes to Illinois a share of income out of all proportion to the taxpayer's market in the state and that the proposed method fairly and accurately apportions income (86 Ill. Adm. Code 100.3390(c)). A zero-over-zero factor is a strong candidate under the distortion standard, because the formula produces no result rather than a skewed one, but the petition must still make the showing, and a taxpayer proposing a constructed denominator is asking to increase its own Illinois share, a posture the distortion language was not written for. A petition is timely under subsection (e)(1) if filed at least 120 days before the due date of the return, including extensions, for which the method is sought; a taxpayer who misses that date files and pays under the statutory method, and an approved petition is granted as a private letter ruling. A taxpayer that filed under the statutory method, or whose (e)(1) petition was rejected, may then petition under subsection (e)(2) with an amended return. And alternative apportionment may be raised in a protest, a Money Disposition Act action, or a Tribunal petition under subsection (e)(3), which covers a notice of deficiency issued as a result of an audit whose adjustments create the need for the petition, and only if the taxpayer requested it in writing from the auditor and was denied, or the audit disallowed an alternative method the taxpayer had been using (86 Ill. Adm. Code 100.3390(e)). In IT 20-0002-GIL (January 21, 2020) the Department found a petition untimely under subsection (e)(1) and directed the petitioner to the (e)(2) and (e)(3) routes. The remedies therefore run in sequence: the notice is answered with the record and the statutory argument; a ruled method for that year comes by amended return with an (e)(2) petition; and later years are petitioned under (e)(1) before the return is due.
The notice-and-protest path in Illinois
A return correction notice is a letter the Department sends when there is a question about the information supplied on the return, and it is answered within the period printed on it. What follows depends on how the Department characterizes the change. If it issues a Notice of Deficiency, the protest rights below apply. If it treats the missing apportionment information as a mathematical error, a term that includes the omission of information called for on the return (35 ILCS 5/1501(a)(12)), the notice of additional tax due is an assessment, is not a notice of deficiency, and carries no right of protest (35 ILCS 5/903(a)(1)); the route then is to pay, file an amended return claiming the refund, with an (e)(2) petition attached if an alternative method is sought, and protest any denial of the claim within 60 days (35 ILCS 5/910(a)); the Tribunal hears claim denials above its threshold (35 ILCS 1010/1-45). After a Notice of Deficiency, the taxpayer has 60 days, or 150 days if outside the United States, to protest (35 ILCS 5/908(a)). Where the amount at issue exceeds $15,000 exclusive of penalties and interest, or only penalties and interest are assessed and they exceed $15,000, the protest must be filed as a petition with the Illinois Independent Tax Tribunal, on a $500 filing fee (35 ILCS 5/908(a); 35 ILCS 1010/1-45, 1-55); below the threshold it goes to the Department's administrative hearings, on Form EAR-14 for income tax. The taxpayer may instead pay under protest under the State Officers and Employees Money Disposition Act (30 ILCS 230/2a, 2a.1) and litigate in circuit court. A notice not protested in time becomes final. Because the regulation bars raising alternative apportionment in a protest or Tribunal petition outside the audit cases in subsection (e)(3), the protest of a 100 percent notice must be framed as what it is, a dispute about what the statute requires on the return as filed; the constructed denominator belongs in an (e)(1) or (e)(2) petition.
A worked example
A holding partnership with no employees and no office in Illinois has base income of $1,000,000. Of that, $600,000 is its distributive share of business income from a non-unitary operating partnership that apportioned 25 percent of its own income to Illinois, so the lower tier reported $150,000 as apportionable to Illinois. The remaining $400,000 is portfolio dividends the holding partnership treats as business income, receipts excluded from the sales factor by Section 304(a)(3)(D). Its own sales factor is zero over zero.
On the return as it should be filed, the $600,000 appears on the non-unitary partnership line and $150,000 on the line for the Illinois portion; the $400,000 is subject to the partnership's own factor; Lines 40 and 41 are zero. Under the reading in IT 21-0008-GIL the $400,000 contributes nothing to Illinois, Illinois base income is $150,000, and at the replacement tax rate of 1.5 percent for partnerships (35 ILCS 5/201(d)) the replacement tax is $2,250 before any exemption or credit.
Suppose the return correction notice describes the apportionment information as missing and applies 100 percent. If it applies the factor only to the partnership's own business income, Illinois base income becomes $550,000 and the tax $8,250; if it treats all base income as derived inside Illinois, the figure is $1,000,000 and the tax $15,000. Either increase is below the Tax Tribunal's $15,000 threshold unless notices for the same year together exceed it, so a protest of the replacement tax alone would go to the Department's administrative hearings. The nonresident partners' Illinois-source income, and the pass-through withholding on it, move by the same multiples.
If the partnership wants a ruled method rather than a standoff, it petitions under Section 304(f), under subsection (e)(2) for the year already filed and under (e)(1) for later years. One construction sources the $400,000 of dividends to the state from which the portfolio is managed, not Illinois, and takes the lower-tier income by the states to which the operating partnership apportioned it, $150,000 Illinois and $450,000 elsewhere. The constructed factor is $150,000 over $1,000,000, or 15 percent. Importing the lower tier's apportionment into the holding partnership's own factor is open to challenge, because the two are not unitary and the lower tier's market is not the holding partnership's market; a petition that uses it, or that mixes income with receipts, should explain why the result fairly represents the holding partnership's own sources of business income. Applied to the $400,000, the factor yields $60,000 of Illinois income and total Illinois base income of $210,000: more than the $150,000 the statute arguably supports, far less than the $550,000 or $1,000,000 the notice imputed. Conceding the $60,000 for a ruled method is a judgment about the entity's tolerance for annual correspondence.
How other states handle the empty factor
Illinois is not alone in its silence, but the silence is not universal. Massachusetts writes the fallback into the statute: a corporation taxable both within and without the commonwealth apportions, since 2025, by the sales factor; if the sales factor is inapplicable, which includes the case where both numerator and denominator are zero, the corporation apportions on its property and payroll in the commonwealth; a sales factor is not inapplicable solely because the numerator is zero; and a corporation with no income taxable in another state allocates the whole of its income to Massachusetts (M.G.L. c. 63, ยง 38(b), (c), (g)). The drafting separates the two questions the Illinois notice collapses: whether the taxpayer is taxable elsewhere at all, and what to do with a factor that cannot be computed.
California reaches a similar place through its equitable relief statute, and the library's article on how a company with no gross receipts apportions its California income covers it: the mandatory single sales factor fails when the denominator is zero, and the path is a petition under Revenue and Taxation Code Section 25137 to exclude the failed factor and include property and payroll. That article addresses a pre-revenue operating company with people and property in the state; the holding entity here has neither, so the constructed denominator is the petition that fits.
Three factor states typically carry a drop rule under which a factor with a zero denominator is omitted and the rest reweighted (for example, Haw. Admin. R. 18-235-29-02), as Illinois's phase-in paragraph did. Those rules work only while a factor is left to weight; in a single sales factor state with no fallback provision the zero factor leaves nothing to reweight, so the first question everywhere is whether the entity's business income is derived solely from that state.
Practice notes
The zero factor should be anticipated at filing rather than discovered on a notice. First, decide before the return is prepared whether the entity's own business income is material; if not, check the Line B box, complete Step 6 with zeros on Lines 40 and 41, and attach a statement reconciling base income to its nonbusiness, lower-tier, and excluded-receipt components. Second, if it is material, file a Section 304(f) petition at least 120 days before the return is due, including extensions, proposing a constructed denominator, and keep the private letter ruling with the workpapers; for a year already filed, the petition goes in with an amended return under subsection (e)(2). Third, answer a return correction notice as a records question, within the period printed on it, without asking for an alternative method there; the (e)(2) amended return is a separate filing. Fourth, read the notice that follows for what it is: after a Notice of Deficiency, calendar the 60 day protest period, let the $15,000 threshold decide between the Tribunal and the Department hearing, and frame the protest as a dispute over what Section 304(a) requires; after a notice of additional tax due assessed as a mathematical error, there is no protest, so pay, file the amended return claiming the refund, and calendar 60 days from any claim denial. Fifth, in every other state where the entity files, check whether the statute has a fallback, a drop rule, or nothing. G&G State Tax Group provides apportionment analysis and notice and protest representation for holding and investment entities alongside its state and local tax practice.
This article states the law as of October 5, 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, or another state and local tax adviser, to confirm what has changed since this was written and how the rules apply to a specific situation.
This publication is informational in nature and is not, and should not be considered, legal, accounting, tax, or other professional advice for any person or situation. Correct application of tax law depends heavily on the facts and circumstances in each case, and G&G State Tax Group, LLC assumes no liability in connection with the use of this information, and is not obligated to inform any reader of changes in the law or other factors that could affect the information contained herein.