Tax Planning

Learn how to handle tax planning as a small enterprise proprietor in a number of states

More and more small businesses now have a multi-state nexus without realizing it, and business owners are exposed to taxes across state lines.

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August 13, 2021 4 min reading time

The opinions of entrepreneurs’ contributors are their own.

The majority of small businesses do not levy taxes outside of their home state. This is simply because they are usually local with no physical locations or connections to other states. But in today’s networked and virtual world, small businesses not only have access to employees in other countries, but also around the world. Hiring a contractor in another country can have its own effects, but luckily none that affect the company’s US taxes.

Hiring an employee or contractor in another state can be problematic as it is easy to link those states. The recent sales tax regulations in the marketplace have created a hot topic, and small business owners may not be aware that a contractor in another state can create not only a sales tax but also an income tax nexus. This means that in addition to collecting sales tax, you also have to file and pay income tax.

Most of the tax planning in multiple states is intended for large corporations that are taxed as C companies. If you own a business that has flow-through taxation, you probably won’t benefit from multi-state taxation, but you still need to deal with it. Learn what business owners can do to manage compliance and tax consequences across states.

Register in your home state

Your company must be registered in the state in which you live. Unless you have a stake in your company, you have Nexus in your country of residence. For most small businesses, registering in another state means more state registration fees with no tax savings, but potentially higher taxes. Registering in another state only helps in very special situations and should only be done if you have discussed this with your CPA.

Watch out for additional taxes

The additional tax burden for small businesses that operate in multiple states can mean double taxation. Not all states offer credit for taxes paid to another state. It is entirely possible to tax the same income in two different states. If you live in a state with no income tax, like Texas or Florida, it may mean paying state income tax on some of your income.

Related: The many variables to consider when choosing which state to include

Manage registration costs

Small business owners do not have the budget to prepare large corporations for tax preparation. Unfortunately, the tax preparation costs for filing in multiple states can be significant. Once you determine which state to file in, you may find that your contribution rate is zero so you have no taxable income. So you have to decide whether to submit or not. If you try to comply with all of the state laws that each state expects, you may find that the cost is greater than the potential penalty for not filing the declarations.

In case of doubt, collect sales tax

If you might have a Nexus, you should be collecting sales taxes. Note that sales tax usually does not affect your sales. There’s no way to go back to your customers and ask them to pay sales tax on past purchases. The government assumes that sales taxes are built in if you don’t collect them. Having a small margin on what you sell can make the difference between making money and losing it.

Related: States are offering ecommerce stores a tax amnesty before they drop the hammer

Don’t believe the gossip

There are always ideas and rumors in the business world about starting your business in State X or State Y. For example, some Californians mistakenly believe that a Wyoming LLC will save them tax money. Unless you’re running the business in WY yourself, this strategy will only cost you extra cash on top of the registration fees paid to WY. If you are a California resident, you pay tax on any income you generate, regardless of the state in which your business is registered.

So are there scenarios in which companies can benefit from tax planning in multiple states? The short answer is yes, but only if your company is taxed as a C company with offices and employees in different states. For the rest of the small business owners who benefit from flow-through taxation, multi-state taxes will mean higher administrative costs and potentially more taxes. Be aware of where it might be related and make sure to pass the information on to your tax advisor or CPA to make sure you are complying with the rules.

Related: Income Tax Basics For Your Startup

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