State and Local Business Taxes
Business owners pay many state and local taxes, some of which are in the form of licenses or user fees. State and local taxes do not depend on where the business was set up, such as the state of incorporation, but rather on where it operates. Tax liability for businesses very much depends on nexus, which means either having a physical presence or a sales force operating within the state. Some taxes are paid as part of the cost of other items, such as the sales tax for equipment or office supplies, for instance.
A business owner must know what taxes must be paid, when and where to deposit the taxes, and what returns must be filed and when. A state tax identification number may be required for the business, and estimated tax payments may have to be made to both the state and the locality. State business return filing deadlines may differ from the federal requirements, so the business should check with the state tax authorities to be sure.
Business taxes will also depend on the type of business entity. Sole proprietors generally file as individuals, filling out specific tax forms, usually Schedule C, to report business revenue and deductions.
Partnerships and limited liability companies (LLCs) are generally treated as pass-through entities that are required to report distributions to partners or members, which is what the federal government also requires. Because partnerships and LLCs are flow-through entities, most states do not tax partnerships and LLCs, but, like the federal government, tax the partners or members. The partnership or LLC may have to file an entity return to provide information to the state, but no tax is usually due with the filing of return. However, a few states do assess taxes on partnerships and LLCs which can vary from state to state, which in many cases, is a flat franchise tax.
Most states also require withholding taxes on partners who are not residents of the state.
S corporations are also not generally taxed. However, they may have to pay taxes assessed on business entities, which may include privilege taxes, net profits taxes, business entity taxes, franchise taxes, a percentage tax of business profits, such as the 8.5% assessed in New Hampshire, the franchise tax, or a gross receipts tax.
In most cases, electing to be an S corporation on the federal level also applies to the states. However, a few states require a separate election for S corporation status. Furthermore, some states such as New York and Rhode Island assess the tax on the S corporation even though it is a pass-through entity. A few jurisdictions, such as Louisiana and the District of Columbia, treat S corporations as C corporations.
C corporations are separate taxable entities from its owners, so they must file their own state and federal tax returns. Many states assess a franchise tax, which is a tax on the right to do business within the state, on C corporations, with a maximum of $800 charged in California.
This article presents an overview — not an exhaustive list —of the various business taxes that are assessed on businesses by the states and their municipalities.
Almost all states have an income tax on businesses, with the exception of Nevada and Wyoming. There is no state income tax on sole proprietors in Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, or Washington, or Wyoming, including limited liability companies that are disregarded entities (meaning that they have only a single member).
How the business is taxed, of course, depends on the type of business entity – sole proprietorship, partnership, S corporation, or C corporation. Most states use the federal income tax as a starting point in the calculation of their own taxes. However, there are differences in rates of depreciation and what is deductible. For instance, while state income taxes are deductible on the federal return, they are not deductible on the state income tax return.
Many states follow the federal rules for depreciation, but many do not. Most of these differences are the disallowance of accelerated depreciation, such as bonus depreciation.
If a business has locations in other states, what is called a nexus, which can include locations where there are employees or independent contractors working for the company in other states, such as the affiliates of Amazon.com, then the business will have to file a state return and pay taxes to each of those states. Sole proprietors must fill out a nonresident state income tax return for those other states. Generally, income and deductions will have to be apportioned among the various states according to the amount of business or revenue earned in each state. Apportionment may be based on a sales factor, payroll, or property. The tax law in the resident state will generally give credit for taxes paid to the nonresident states. Treatment of income and deductions can differ in different states, which can greatly increase the complexity of returns. Therefore business owners should probably consult a tax professional in those situations.
Although the credit for paying taxes in other states is generally applied to the home state tax return, in some cases, the credit may have to be taken on the nonresident tax return, depending on the state.
Service taxes, which depends on the sourcing of services revenue, are taxes on services performed out-of-state that benefits businesses within that state. Generally, no credit can be claimed for these out-of-state taxes, although they are generally deductible. The states that assess these service taxes include California, Georgia, Illinois, Iowa, Maine, Maryland, Michigan, Minnesota, Ohio, Oklahoma, Utah, Washington, and Wisconsin.
Local Income Taxes
Many municipalities also assess a local income tax. A municipality can be a city, county, or region. Most local business income taxes are assessed by either the city or the county. Generally, municipal taxes will be both more numerous and higher in larger cities. For instance, New York City and Philadelphia are the most taxing jurisdictions in the United States.
Excise taxes are like sales taxes, in that a specific percentage of the retail price is assessed, but unlike sales taxes, applies to a more specific category of goods or services. Excise taxes were the only source of revenue for the federal government until 1913, when the income tax was instituted. Sometimes excise taxes are enacted to pay for specific items, such as the telephone excise tax that was used to finance the Spanish-American War of 1898. However, like most taxes, once enacted, the government rarely rescinds the tax. Hence, the telephone excise tax, for instance, continued to be assessed more than 100 years after the end of the Spanish-American War. Excise taxes include environmental taxes, taxes on air transportation, communication, fuel, and on the sale of heavy trucks, trailers, and tractors.
Excise taxes are usually assessed on the retail price of products, such as cigarettes or alcohol. To pay these taxes, generally the business must maintain sales records for the number of items sold. Depending on the gross receipts of the business and the tax, the business may have to file returns monthly, quarterly, or annually.
Gross Receipts Tax
Whereas an income tax is a tax on business profits, a gross receipts tax, sometimes called a business tax, is a tax on total revenues. There are generally no deductions against the gross receipts tax, which is why it is called that. Although different states give the gross receipts tax a different name, states that charge these taxes include: Arizona, Delaware, Hawaii, New Mexico, Ohio, Oregon, Pennsylvania, Texas, Washington, and West Virginia.
The gross receipts tax can vary from less than 1% to 4%. The percentage rate also usually varies according to the type of business such as retail, manufacturing, or wholesaling. For instance, Delaware assesses a gross receipts tax that ranges from 0.1% to slightly more than 2% with an exclusion of $80,000 per month for most categories.
The general receipts tax may allow an exemption, or the deduction of cost of goods sold or compensation, or maybe a percentage of total revenue. The gross receipts tax assessed by some localities is often called business license fees, but they are assessed on the gross receipts of the business.
Sales and Use Taxes
Most states charge a sales tax, except for Alaska, Delaware, Montana, New Hampshire, and Oregon. A sales tax is usually a percentage tax assessed on the retail prices of goods and sometimes services. The sales taxes collected by the business must be remitted to the state. How frequently the sales tax is remitted usually depends on the total amount of sales tax collected by the business.
Every state that has a sales tax also has a use tax, which is assessed on the buyers when they buy a product from out of state, since in most cases, the out-of-state seller does not charge a sales tax on the purchase by an out-of-state customer unless the seller has a nexus in that state.
Generally, the business charges a sales tax for all items sold that are subject to the tax. If the business sells to another business that is going to resell the product, then most state tax agencies require a resale certificate that is assigned to the buyer and a copy of the sales tax license of the buyer. If the business fails to properly document these nontax sales, then it may have to pay the tax.
Sales tax obligations to several states can be simplified by using a Certified Service Provider (CSP), which is a company approved by the sales tax governing board, to help a business to properly collect and remit the tax to the CSP, who then pays it to the appropriate states. There is no cost to the business owner since the states pay for it.
Real Estate and Personal Property Taxes
Businesses, like most taxpayers, must pay real estate property taxes on any real estate that they own, usually to the municipality in which the property is located.
Many states or localities also assess personal property taxes on machinery, equipment, supplies, and in some cases, inventory. If a business has multiple locations, then a personal property report must be filed for each location. Since the tax authorities generally retain records of personal property reported in previous years, the business should note what properties have been added or disposed of.
Local Business Licenses
Most localities charge a nominal business fee. However, the fee may be commensurate with the number of employees. An occupancy permit may also be required. Additional fees may be assessed if the locality sends someone to inspect the business, such as to check zoning. Some inspections will depend on the type of business, such as a restaurant or other food service that requires an inspection by the health inspector or if the business deals with hazardous waste, which may require an inspection by the fire department or some other agency.
User fees are also assessed by many localities, such as a building permit for constructing a building or to make changes to existing structures.
All taxes are ultimately paid by people. When businesses are taxed, they simply pass their cost in the pricing of their products or services. So why are there so many different taxes on businesses? Partly because every locality has several taxing authorities, but also because it is an effective way to tax the people without their knowledge.