Key Takeaways
- A California trial court ruled that Smithfield Foods is entitled to use a traditional three-factor apportionment formula (property, payroll, and sales) rather than California’s standard single sales factor method.
- The court found two independent grounds for this ruling:
- Smithfield qualifies as an agricultural business under California Revenue and Taxation Code § 25128(b),
- The single sales factor produced a distortive result under § 25137’s alternative apportionment provisions.
- California’s Regulation 25128-2, which used a product-based test to determine agricultural status, was found invalid as applied to Smithfield.
- The § 25137 analysis has broad implications for any multistate business whose California sales significantly exceed its total California operations.
- This decision is being called one of the most significant state tax cases in recent memory, with tax policy advisors suggesting more challenges to single sales factor apportionment are likely to follow.
When a California trial court issued its ruling in Smithfield Packaged Meats Corp. v. California Franchise Tax Board in late February 2026, the state and local tax world took notice. And for good reason: the decision doesn’t just affect pork producers. It raises serious questions about whether California’s single sales factor apportionment formula fairly reflects the in-state business activity of companies whose core operations happen to be located elsewhere.
Here’s what happened, why it matters, and what multistate businesses should be thinking about right now.
The Background: How California Taxes Multistate Income
States apportion multistate business income using formulas intended to reflect in‑state activity. Historically, the Uniform Division of Income for Tax Purposes Act (UDITPA) used an equally weighted three‑factor formula based on:
- The proportion of a company’s property
- Payroll
- Sales located in the state
California originally followed this model. But starting in 1993 and culminating with the passage of Proposition 39 in 2012, California shifted to a single sales factor formula. Meaning only where a company sells its products determines how much of its income California can tax. The rationale was straightforward: by removing property and payroll from the formula, California could encourage businesses to invest and hire in the state without increasing their California tax burden.
There’s a notable carve-out, however. Under § 25128(b), businesses that derive more than 50% of their gross receipts from agricultural or extractive activities are still required to use the traditional three-factor formula. The logic is that farms, ranches, and mining operations can’t simply relocate to California to chase a tax incentive as their business activities are geographically constrained.
The Smithfield Case: Two Roads to the Same Destination
Smithfield, the world’s largest hog producer, operates more than 2,000 hog farms, eight large-scale harvesting facilities, and over 30 processing plants. Virtually none of them are in California. Its only California presence in 2014 was a single small, leased facility (the “Mohawk” plant) that produced bacon and corned beef and accounted for less than 0.5% of the company’s total product volume. Yet under California’s single sales factor formula, 6.65% of Smithfield’s income was attributed to California.
Smithfield argued that was deeply unfair, and the court agreed, on two separate and independent grounds.
Ground One: Smithfield Is an Agricultural Business
The California Franchise Tax Board (FTB) argued Smithfield didn’t qualify as an agricultural business because its products were “processed.” Under Regulation 25128-2, receipts from processed animals were excluded from agricultural receipts. Under that framework, only receipts from the sale of live hogs (less than 4% of Smithfield’s total receipts) counted as agricultural.
The court rejected this product-based approach outright. The statute itself asks about a taxpayer’s activities, not the character of the final product on the shelf. Smithfield raised 14.7 million hogs in 2014 across a network of farms that employed geneticists, veterinarians, and farm staff, operating within a USDA-regulated framework from birth to harvest. The court found that 61.34% of Smithfield’s gross receipts were attributable to agricultural business activities when analyzed on an activity basis. This number is well above the 50% threshold required under § 25128(b).
The court also found Regulation 25128-2 itself to be invalid as applied to Smithfield, because it conflicted with the plain language and legislative purpose of the governing statute. A regulation that ignores the activities driving a company’s income, focusing instead only on whether the final product has been processed, doesn’t survive scrutiny when the statute it purports to implement says something fundamentally different.
Ground Two: The Single Sales Factor Doesn’t Fairly Represent Smithfield’s California Activity
This is where the ruling gets particularly interesting for businesses outside the agricultural sector.
Independently, the court found that Smithfield was qualified to use three-factor apportionment under § 25137 (California’s alternative apportionment provision). This statute allows a taxpayer to use a different apportionment method when the standard formula doesn’t fairly represent the extent of the taxpayer’s business activity in the state.
Under § 25137, a taxpayer bears the burden of proving by clear and convincing evidence that (1) the standard formula produces a distortive result, and (2) the proposed alternative is reasonable. Smithfield met that burden.
The court’s analysis under § 25137 is worth examining in-depth, because it directly addresses how “business activity” should be understood in the context of the apportionment relief provision.
What does “business activity” actually mean under § 25137?
The FTB argued that “business activity” for purposes of § 25137 should be interpreted narrowly, limited to sales activity. Under that view, because Smithfield sold a meaningful percentage of its products into California, the single sales factor fairly captured its California presence.
The court flatly rejected this interpretation. Drawing on established California case law, including Appeal of Merrill, Lynch, Pierce, Fenner & Smith, Inc. and Communications Satellite Corp. v. Franchise Tax Board, the court held that “business activity” encompasses all income-generating activities conducted by the taxpayer, not just sales. This includes the activities of employees (reflected in the payroll factor) and the use and availability of property (reflected in the property factor). A formula that ignores where a company’s people work and where its capital is deployed cannot, by definition, fairly represent that company’s business activity in a state.
The court cited the foundational principle from Hoffmann-LaRoche, Inc. v. Franchise Tax Board: net income is not generated at the point of delivery. It is the result of all the activities involved in developing, producing, and marketing a product. The question for apportionment purposes is where those income-generating activities occur, not simply where the final transaction takes place.
Measuring the distortion
Using the comparable profits method, Smithfield’s financial analyst demonstrated that only 1.02% of Smithfield’s total income-generating activities occurred in California. California’s single sales factor formula, however, attributed 6.65% of Smithfield’s income to the state, resulting in a difference of more than 600%. The court noted that far more modest distortions have been found sufficient to justify alternative apportionment in prior California cases. A 600% overstatement of California activity left little room for debate.
The court also found that the traditional three-factor formula was a reasonable alternative. It served as California’s standard apportionment formula for nearly four decades, continues to apply to agricultural and extractive businesses, and has been described as the “benchmark” formula by both the U.S. Supreme Court and the California Supreme Court. There’s nothing exotic or untested about it.
Why This Matters Beyond Agriculture
The § 25137 analysis in Smithfield has implications that reach far beyond hog farming. The court’s holding, that “business activity” includes all income-generating activities, not just sales, is a direct challenge to the FTB’s narrow interpretation of the alternative apportionment provision.
Any multistate business that generates significant California sales but has minimal California property and payroll should assess whether its California apportionment factor materially overstates its actual California business activity. This could include manufacturers, distributors, agricultural processors, and others whose production operations are concentrated outside California but whose products flow into the California market.
The court emphasized that income is generated by all activities involved in producing and marketing a product, not merely the point of sale.
The expert witness who testified on behalf of Smithfield at trial put it directly: the single sales factor was designed for economic development purposes – to incentivize businesses to locate in California. When a business has no real capacity to move its operations into California regardless of the tax incentive, applying a formula designed around that incentive produces results that are neither fair nor reflective of economic reality.
What Multistate Businesses Should Do Now
This ruling is still at the trial court level and may be subject to appeal. But the reasoning is grounded in statute and established case law, and the underlying tension between single-factor apportionment and the realities of geographically constrained businesses isn’t going away. If anything, this decision signals that courts are willing to take § 25137 claims seriously when the facts support them.
For businesses operating across state lines, this is the right time to take a hard look at your California apportionment position and ask whether the formula you’re using actually reflects where your income is generated.
Businesses should:
- Compare their California apportionment percentage to the actual location of property, payroll, and operations
- Evaluate whether the single‑sales‑factor formula materially overstates California activity
- Consider whether a § 25137 petition is appropriate
Rea’s State & Local Tax advisors can help you evaluate your exposure, assess whether alternative apportionment may be warranted in your situation, and navigate the evolving landscape of multistate tax compliance.
About the Author
Corey Dillon, CPA, MBA is a State & Local Tax Manager at Rea, bringing a focused practice in multistate tax compliance and planning. A Certified Public Accountant credentialed through the AICPA, Corey works with businesses navigating the complexities of multistate income apportionment, nexus determinations, and state tax compliance across a variety of industries. His work helps business owners and finance leaders understand not just what the rules are, but how those rules affect their bottom line — and where opportunities exist to ensure their state tax positions reflect the true nature of their operations.
Have questions about your California apportionment position or other state and local tax matters? Connect with Corey and the Rea State & Local Tax team at reaadvisory.com.
