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State Taxation 101: Understanding the Different Types of State Business Taxes

State Taxation 101

Technology has empowered us to be more connected than ever.  In turn, companies can easily conduct business, sell goods, and perform services nationwide.  Although this expanded market can lead to increases in sales and net profits, there are also added challenges that arise when transacting business in numerous states. 

One of the additional complexities that is frequently overlooked is the potential to be subject to tax in a new state jurisdiction.  State and local tax can be a detailed and cumbersome area of practice.  However, have no fear – we have put together a mini-series that will discuss the various challenges and regulations that many businesses find themselves facing under increasingly complex state tax structures.  

To get acquainted with state taxes, we wanted to introduce the varying types of taxes that you could potentially be subject to if you are transacting business outside of your home state.  

Traditional Income Tax

Income tax is perhaps the most commonly known and widely used type of state tax.  State income tax is usually based on a company's federal taxable income with specific adjustments made for state purposes. Every state sets their own rules relative to the adjustments required in order to determine the state’s taxable income.  

The income tax liability is determined by applying a specific tax rate to the state taxable income.  Income tax rates can vary significantly and are set by each individual state.  Some states have a flat tax rate (for example, North Carolina has a flat rate of 2.5%).  While other states impose a graduated tax rate as state taxable income increases (for example: New York’s corporate tax rate varies from 6.5% to 7.25%).

Since state income tax is determined by applying a tax rate to the state taxable income, companies with a state net operating loss will not have income tax in the state for that year.  However, they are often still required to file a tax return for that state.

Franchise Tax

Franchise tax is levied on businesses or corporations operating within a state's jurisdiction.  Unlike the traditional income tax described above, which focuses on the net income of a business, the franchise tax is often a flat fee imposed for the privilege of doing business in a particular state.   Since the franchise tax is not based on net income, companies conducting business in states with franchise tax will be required to pay this fee even if they have a taxable loss.

It is important to note that not all states levy a franchise tax, and the specific regulations and fees can vary significantly between jurisdictions.  In most cases, a franchise tax does not replace income tax, but rather is an additional fee on top of traditional state income tax.

Below are several examples of different state franchise taxes that are currently imposed -

  • Delaware imposes a minimum $175 franchise tax fee on businesses that are registered in the state.
  • If you are registered to do business in the state of California, a $800 minimum annual franchise tax is imposed.

Gross Receipts Tax

A gross receipts tax is imposed on the total revenue or gross sales of a business.  The gross receipts tax does not take into account items of deduction, such as cost of goods sold or operating expenses.  Instead, a lower tax rate is imposed on all receipts generated in the particular state.  Like the franchise tax, businesses with net losses will still have to pay the gross receipts tax.

Below are several examples of states that currently utilize a gross receipts tax:

  • Ohio has established the Commercial Activity Tax (CAT).  Businesses with Ohio taxable gross receipts of more than $150,000 per calendar year must register and file the CAT.  The CAT currently utilizes a tiered structure with a .26% tax rate and has a minimum tax of $150.
  • Washington does not have an individual or corporate income tax.  However, it currently utilizes the B&O (business and occupation) tax on gross receipts.  The tax rates vary based on business classification and are imposed on a business’ gross receipts. 

As demonstrated above, the three primary types of state taxes vary greatly depending on the state legislation.  Each tax type has its own unique structure and method of calculation, leading to variations in rates and regulations across different jurisdictions.

Understanding the different types of state taxes is crucial for businesses to effectively manage their tax obligations and filings.  If you are transacting business in multiple states, please contact your tax professional at Dermody, Burke & Brown so we can help you navigate the complexities of state income taxes.

The information reflected in this article was current at the time of publication.  This information will not be modified or updated for any subsequent tax law changes, if any.

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