If your business has grown to operating in more than one state, you will need to file taxes for each location. Doing so can be tricky, but knowing some basic information can help you get ready for tax season with ease.
Filing as an S corporation
To avoid paying federal corporate taxes, some businesses meet Internal Revenue Code requirements and can qualify to file as an S corporation, or S subchapter. Doing so allows the business to pass income, deductions, losses, and credits directly to shareholders. What this means is these individuals can report business-related items on their personal taxes and pay taxes at standard rates rather than possibly higher small business rates, depending on the state. Some states, however, do not allow businesses to pass tax attributes to shareholders and instead treat them just like C corporations, which are taxed separately from owners.
Get to know state tax rules
Business expansion is a great way to increase profits, but when it comes time to file taxes, it can bring upon a handful of concerns. Getting to know each state’s tax rules ahead of time, regarding who must file and how to do so, is vital. Each state has a different definition of what is taxable, ranging from the equipment you use to the goods or service you sell and more. According to Policy Analyst Janelle Cammenga, writing for The Tax Foundation, Wyoming and South Dakota are the only two states that don’t require a combination of privilege and corporate income taxes for businesses. There are many other rules and guidelines that must be followed in each state, and it is in your best interest to educate yourself as early as possible so you can prepare.
Income apportioning
To avoid paying state taxes on the same income more than once, it’s required businesses filing multiple state income taxes must allocate — or apportion — that income between the states that their business is located in. The traditional way of calculating these taxes is based on an equal combination of the percentage of payroll, company property, and sales located within the state. However, more states have started to adopt the single sales factor apportionment, which means only the sales of the business are taken out to benefit in-state production. According to The Tax Foundation, 29 states were using the single sales apportionment method in 2020 while six used the traditional three-factor method. Other states used methods of either 50% of sales or more than 50% of sales.
Nexus creation
Some regulations for filing business taxes are similar across many states. One such instance of this is when a business creates a nexus. While almost all states have laws for nexus creations, each state will have varying thresholds. “Typical qualifying activities include having a physical presence in the state and having employees who regularly work in the state,” says business writer Sean Butner of Chron. Even with these variables, most state income tax for businesses is determined partly by the employees in the state, income generated there, and any leased or owned property. In some cases, you may even create a sales tax nexus since it varies from state to state.
To truly know if your business needs to file multiple state taxes and what you will need to do so, it is best to contact local IRS offices in each state that your business is located.