There are a number of considerations that a business owner may take into account when deciding upon the best state in which to incorporate. One factor that is often important to business owners is the taxes that will be imposed on the newly formed corporation. Both the type of taxes for which a business is responsible and the tax rate can vary depending on the state in which the business is incorporated. The majority of states in the U.S. levy corporate income taxes on corporations, however, not all states do. Furthermore, this corporate tax rate is notably high in some states and notably low in others.
Corporate Income Tax Rates
Of the 50 states in the United States, 44 of them levy a corporate income tax. Only the states of Nevada, Ohio, South Dakota, Texas, Washington, and Wyoming do not levy corporate income taxes. The rate of the corporate income tax can vary from state to state. Only six states tax corporations at a tax rate of nine percent or higher: Alaska, Connecticut, Iowa, Minnesota, New Jersey and Pennsylvania as well as Washington D.C. The states of Colorado, Mississippi, North Carolina, North Dakota, South Carolina, and Utah have a significantly lower corporate income tax rate, which is equal to or below five percent.
Gross Receipts Tax
The states of Nevada, Ohio, Texas, and Washington do not levy a corporate income tax. Instead, these four states tax corporations by imposing gross receipts taxes. In addition, the states of Alabama and Florida impose gross receipts taxes on some or all utilities. Delaware, Hawaii, Illinois, New Mexico, Pennsylvania, and Virginia all have some form of gross receipts taxes on applicable businesses as well.
A gross receipts tax is a tax levied based on the total gross revenue that a corporation generates. It differs from a corporate income tax due to the fact that it is based on general gross receipts, not simply income. Furthermore, gross receipts taxes allow room for far fewer deductions for business expenses than corporate income taxes.
In addition, gross receipts taxes differ from sales taxes because they are applied to all transactions instead of only final retail sales. For these reasons, many financial analysts believe that the gross receipts tax is actually worse for businesses than the corporate income tax.
The state of Texas imposes a gross receipts tax in the form of a franchise tax, based on the taxable margin of the entity. Ohio primarily utilizes the commercial activity tax. The state of Washington even taxes sole proprietorships with its business and occupation tax. There are different tax rates within the state, depending on the business activity classification of the business.
It is important to note that the states of Delaware and Virginia impose both corporate income taxes and gross receipts taxes on corporations. It is also important to note that gross receipts taxes are not limited to corporations and can be applicable to C corporations, S corporations, and partnerships, as well as limited liability companies and, in some cases, sole proprietorships. Furthermore, for gross receipts taxes to be imposed, there is no physical presence requirement within a state; some states have implemented a sales threshold, which subjects businesses to a gross receipts tax if they surpass the threshold.
There are only two states in the United States that do not impose either a corporate income tax or a gross receipts tax. These states are South Dakota and Wyoming and it is relatively easy to incorporate in Wyoming.