An Explanation of State Business Taxes

State business taxes are levies imposed by state governments on a company’s income and activities within their borders, funding public services like infrastructure and education. The framework for business taxation is not uniform, as each state establishes its own tax laws, regulations, and rates. This diversity means a business’s tax obligations can differ significantly based on its location.

Some states tax corporate profits at a high rate, while others impose no corporate income tax. A business might be subject to taxes on its net profits, total revenue, property, or the privilege of maintaining a corporate charter. Understanding these variations is a fundamental part of multi-state business operations and financial planning, as companies must navigate a distinct set of tax laws for each jurisdiction.

Determining Your State Tax Obligation (Nexus)

A state can only require a business to collect or pay taxes if the business has a sufficient connection, or “nexus,” with that state. This principle ensures a state does not overstep its constitutional authority. The determination of nexus is the first step a company must take to understand its state tax responsibilities.

The traditional standard for establishing this connection has been physical presence. If a business has tangible assets or personnel within a state’s borders, it creates physical presence nexus. Examples include maintaining an office or warehouse, employing individuals in the state, storing inventory in a fulfillment center, or having representatives solicit sales.

A more recent standard is economic nexus, which allows a state to assert a tax obligation based on a company’s economic activity, even without a physical presence. This concept was solidified for sales tax by the 2018 Supreme Court decision in South Dakota v. Wayfair, Inc., which overturned the physical presence requirement. Following the ruling, most states with a sales tax adopted economic nexus laws, often requiring a remote seller to collect sales tax if they exceed a threshold like $100,000 in sales or 200 separate transactions into the state annually.

The concept of economic nexus is also expanding beyond sales tax. A number of states now apply similar standards to other business taxes, including corporate income and franchise taxes. This means a business could be liable for a state’s income tax based solely on its sales volume into that state, complicating compliance for companies selling nationwide.

Common Types of State Business Taxes

Corporate Income Tax

Corporate income tax is a direct tax levied by a state on a company’s net profits earned within its jurisdiction. The calculation begins with federal taxable income, which is then adjusted according to state-specific rules. These modifications can include additions for income the federal government does not tax or subtractions for expenses the state allows.

Tax rates vary, with some states using a flat rate while others employ a graduated structure where rates increase with profits. For businesses operating in multiple states, income is divided among them through a process called apportionment to ensure it is not fully taxed in every state.

Franchise Tax

A franchise tax is a levy for the privilege of being incorporated or doing business in a state. Unlike income tax, it is often calculated on a company’s net worth or capital, meaning a business may owe franchise tax even without a profit.

Calculation methods differ widely; some states base the tax on capital stock or net worth, while others have unique models like the Texas Margin Tax. A number of states impose a minimum franchise tax, such as California’s $800 annual minimum for most corporations, which is a flat fee every registered entity must pay.

Sales and Use Tax

Sales tax is a consumption tax on the sale of goods and certain services. Businesses are responsible for collecting this tax from customers and remitting the funds to state and local authorities. A use tax complements the sales tax, levied on goods or services when sales tax was not paid at purchase.

A common scenario is when a business buys supplies from an out-of-state vendor that does not collect the state’s sales tax; the business must then self-assess and pay the use tax directly. The administration of sales and use tax is complex due to varying rates and taxability rules across thousands of state and local jurisdictions.

Gross Receipts Tax (GRT)

A gross receipts tax (GRT) is levied on a business’s total revenues with few or no deductions for expenses, distinguishing it from an income tax on net profits. A GRT is owed regardless of profitability and can be burdensome for low-margin businesses.

Several states use a GRT, such as the Ohio Commercial Activity Tax or the Washington Business and Occupation Tax. These taxes can lead to “tax pyramiding,” where the tax is applied at multiple stages of production. The cost of the tax at each stage becomes embedded in the final price, which can obscure the total tax burden.

State Employment Taxes

Businesses with employees are subject to state employment taxes separate from federal obligations. The most common is the State Unemployment Tax Act (SUTA) tax, paid by the employer to fund state unemployment benefits. SUTA tax is calculated as a percentage of each employee’s wages up to a state-specific annual limit, or wage base.

New employers start at a standard rate, which is later adjusted based on an “experience rating” that reflects the number of former employees who have filed for benefits. In some states, businesses must also withhold taxes for state-mandated disability insurance or paid family leave programs, which are often funded by employee withholdings.

Business Structure and Tax Implications

Pass-Through Entities (Sole Proprietorships, Partnerships, S Corporations, LLCs)

The tax treatment of a business is influenced by its legal structure. Pass-through entities, including sole proprietorships, partnerships, S corporations, and most LLCs, do not pay income tax at the business level. Instead, profits and losses are “passed through” to the owners, who report this on their personal state income tax returns.

While this avoids the double taxation of C corporations, these businesses are still responsible for other state taxes like sales and franchise taxes. In response to the federal $10,000 cap on state and local tax (SALT) deductions, many states have enacted an elective Pass-Through Entity Tax (PTET), allowing the business to pay state income tax on behalf of its owners.

C Corporations

A C corporation is legally and financially distinct from its owners. It is taxed directly on its net income at the entity level, filing its own state corporate income tax return. This structure can lead to double taxation.

The first tax occurs when the corporation pays income tax on its profits. A second layer of tax occurs if the corporation distributes after-tax profits to shareholders as dividends, as shareholders must report that dividend income on their personal tax returns. The same corporate earnings are therefore taxed twice.

LLCs

The Limited Liability Company (LLC) offers flexibility in its tax treatment. By default, a single-member LLC is taxed as a sole proprietorship, while a multi-member LLC is taxed as a partnership, making both pass-through entities for income tax.

An LLC can change this default classification by filing an election with the IRS. Through this election, an LLC can choose to be taxed as a C corporation or an S corporation, which controls how its income is treated for federal and state income tax purposes. This allows owners to select the structure that best fits their financial situation, such as electing S corporation status for potential payroll tax savings.

Multi-State Income Apportionment

Allocation vs. Apportionment

When a business earns income in multiple states, states use two methods to divide that income for taxation: allocation and apportionment. Allocation assigns specific types of non-business income entirely to a single state, such as rental income from a property being allocated to the state where the property is located.

Apportionment is the method used to divide a company’s primary business income among the states where it has nexus. The process uses a formula to reasonably reflect the extent of a company’s business activity in each state.

Apportionment Formulas

The core of apportionment is a formula that calculates a percentage, or factor, representing a company’s activity in a state. Historically, a common approach was an equally weighted three-factor formula based on the in-state proportion of a company’s property, payroll, and sales.

Over time, many states shifted to formulas that gave extra weight to the sales factor. Today, a majority of states have adopted a single-sales factor apportionment formula, where business income is apportioned based solely on the percentage of its total sales that occur in that state. For example, if a business has 40% of its sales in a single-sales factor state, it would report 40% of its apportionable income as taxable to that state.

State Tax Registration and Filing

Registering with State Agencies

Once a business determines it has nexus in a state, it must register with the appropriate state agencies, such as the Department of Revenue. Most states offer an online application where the business provides its legal name, federal Employer Identification Number (EIN), and the date it began activities. The company also specifies which taxes it expects to pay.

Upon completion, the state issues one or more tax identification numbers for all future filings. Failing to register in a timely manner can lead to penalties and back taxes.

Filing and Payment Process

After registering, a business must file tax returns and remit payments according to a recurring schedule. Filing frequency depends on the tax type and volume, with sales tax often due monthly or quarterly and income tax annually. Most states require businesses to file returns and make payments electronically through online tax portals.

Missing deadlines can result in late-filing penalties and interest charges. Businesses must maintain copies of all filed state tax returns and supporting documentation for the duration of the state’s statute of limitations, which is generally three to four years, in case of an audit.