State Income Tax: What Every Business Owner Should Know

Most states impose taxes on businesses that sell taxable products or services, own equipment or property and have employees. Companies must also pay state sales taxes and may need to pay quarterly estimated taxes.

Many proposals to cut income taxes claim they will bolster small business investment. However, cuts to personal income taxes disproportionately benefit the wealthiest households and could reduce states’ ability to invest in education, infrastructure and other critical public services.Tax Rates

A state income tax is imposed at a fixed or graduated rate on individuals, corporations and other business entities. In general, state taxable income conforms closely to federal taxable income with limited modifications for state rules relating to deductions and depreciation. State tax rates vary widely across the country. In 2022, New Jersey will have the highest corporate tax rate in the nation at 11.5%, while North Carolina will have the lowest flat rate at 2.5%. States with individual income taxes have rates that range from zero percent to more than 13%. Some states also have local and county taxes on top of the state rate. In addition, federal income taxes impose another layer of complexity. The result is that business owners have to consider the overall tax environment when choosing where to locate their businesses. While cutting business taxes may improve a state’s competitiveness, merely reducing tax rates alone cannot create jobs. Government spending creates jobs in the public sector, while private-sector job creation depends on the value of what businesses produce. In the short term, hiring decisions will be made based on whether the demand for the goods and services the business grows exceeds what the existing workforce can have. Savings from a state’s income tax rate won’t factor into these decisions. However, the location of other companies in a particular industry might.Filing Requirements

Most states require tax filers to report their earnings and deductions on a state income tax return. These returns typically include a summary of the business’s taxable sales and purchases during a reporting period, such as monthly, quarterly or annually. Filing accurately and on time is critical to maintaining compliance with state business tax laws and regulations. The filing requirements for state income taxes vary among states, but most conform to federal rules for income recognition and deductions. Some states also require that a copy of the taxpayer’s federal income tax return be attached to the state’s return. Many states also impose local income taxes, such as property or sales tax. In these cases, taxpayers may need to file several different state tax returns, depending on the locality and structure of their businesses. Some states, including Alaska, Florida, Nevada, South Dakota, Tennessee, and Texas, do not levy an individual income tax. Other states, such as New Hampshire, do not tax earned wages. Taxpayers must remember that cutting state personal income taxes does not automatically promote economic growth and job creation, even if the cuts are passed on to small businesses through lower business costs. In reality, most small business owners intend to hire something other than additional workers in response to a cut in state income taxes. Rather, they hire employees only when the value of the additional output that workers produce exceeds the cost of employing them.Deductions

Many states have a wide range of deductions available, including deductions for state income taxes, property taxes, sales taxes, personal property taxes, and utility taxes. In addition, most states exempt from taxation income from bonds issued by the state or local governments and some portion of Social Security benefits. The SALT (state and local tax) deduction is a favorite deduction for people who file federal income taxes, especially among high-income taxpayers. Defenders of the SALT deduction argue that the federal government is effectively subsidizing taxpayers who pay property and sales taxes by allowing them to deduct them from their overall income. In addition, they point out that SALT payments are mandatory; people can’t choose not to pay them. However, there’s no empirical evidence that the SALT deduction substantially affects entrepreneurial activity or individuals’ decision to relocate to states with lower taxes. Indeed, careful economic studies across the ideological spectrum show no relationship between state income tax levels and business growth. If the SALT deduction were eliminated, it would likely make it harder for states to raise funds for public services, such as education, health care and infrastructure. This could make it more expensive for states and localities to borrow on the bond market. This is because rating agencies look at actions that make it more difficult for states and localities to raise revenue as a credit negative.Electronic Filing

Filing state income taxes often feels like an afterthought, especially after you’ve invested so much time in filing federal returns. However, take into account the importance of filing your state taxes. State taxable income, deductions and credits are critical to determining your business’s tax liability or refund. Moreover, your itemized federal deductions may include state and local income taxes (although the nature of these deductions will vary by state). Many small businesses are required to pay excise taxes. These taxes are levied on the sales or consumption of specific products or services and can vary by state. These taxes include gasoline, sports wagering, indoor tanning and other items. You should check with your local or state taxing authority or a qualified tax professional to determine whether these taxes apply to you and how to calculate them. Starting in 2024, taxpayers who file ten or more forms, notices, reports or statements with the IRS must file them electronically however, you are automatically exempt from this requirement. However, if you’re an unrepresented party, you can choose to participate if you’d like.

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