Multi-State Business: Where to Pay TaxAug 10, 2021
More than ever, businesses are finding clients or customers in multiple states or having employees who live in multiple states. What this means for taxes can be very confusing for a small business owner.
When you operate a business in multiple states you need to learn some information about operating in the new state to know what the tax impact may be to you and your business. You will need to do some research and it is recommended to consult with an attorney and a tax professional to learn the state laws and rules regarding:
- Registering your business
- Business taxes and fees
- Sales tax
- Income tax
No two states have identical rules. As soon as you begin operating or employing workers in more than one state, your business operations will potentially become more complex.
This topic can be overwhelming especially at first. This guide can help you know what questions to ask and begin to determine how operating in multiple states can impact your business. You may need to revisit these topics several times. Be assured that operating in multiple states is possible, many do it, and if you pace yourself you can accomplish this goal.
Registering your business
Doing business in another state usually means registering as a "foreign" (out of state) business entity, as opposed to a "domestic" (original state) entity. Or you may potentially create a new business entity in the new state if the operations are substantially different and stand on their own as a separate business.
You may not need to register the moment you get one new client or have a few transactions in another state, depending on that states rules, but if you are planning to operate, advertise, and conduct regular business in a state then registering may be required.
Where and how to register
Registering a business is typically done via completing forms on the Secretary of State website. If the forms are complicated, seek assistance from an attorney. LLC formation is typically straight forward, though some states make it complicated. It is a good idea to use an attorney to form your LLC Operating Agreement, even if there is one owner. Forming a Corporation almost always requires the assistance of an attorney because it involves creating legal documents. Be wary of online services that are not attorneys, they could be practicing law without a license, or that are national and may not know your state specific rules.
Form of business
States can have varying laws regarding what business structure or formation is permitted for different business types. For example, California does not permit licensed professionals to operate under an LLC, so an LLC from another state may not be able to operate in California. Certain licensed professionals in PA would operate a regular LLC, but in NY would need to open a PLLC. Before operating in a new state, ensure you understand that states rules about the types of businesses structures that are allowed.
Business tax and licenses
Most small businesses do not pay income tax at the business level, as most are pass through business entities. Sole proprietors, LLCs and entities taxes as an S-Corp are all pass through entities, meaning the income of the business passes through to the owner and is taxed at the owners tax rate. However, there can be taxes and fees owed by the business itself for operating a business in a state.
Gross revenue tax
A gross revenue tax (GRT) is tax on business gross income, meaning before expenses are deducted. Washington State has a Business and Occupational Tax (B&O tax) which taxes a small percent (for most businesses between 0.5%-1.5%) of the gross income from the business. Ohio State has a Commercial Activity Tax (CAT) for the privilege of doing business in Ohio. Businesses with gross receipts of $150,000 per calendar year or more must register for the CAT and out of state businesses who meet certain criteria and have a "bright-line presence" in Ohio, may have to pay the tax as well. See FAQ #7 on this page for more details.
Business license fees
Whether your business needs to obtain a business license or pay business fees is typically determined by your physical business location. Business license requirements can be created by a state, county or local government. Wherever your business operates or has employees it is wise to check the state, county and city/town for any business license requirements. You can search online for the state, county and city/town and "business license" as well as contact the local government offices and consult with an attorney to ensure you have covered this potential requirement.
Sales and use tax
If you sell products, you very likely need to collect and pay sales tax for the state/local area of the purchasers address or to your own state. Most businesses that sell products need to register with the sales tax authority as a seller.
Each state defines for themselves what type of sales require collecting and remitting sales tax. Most often these definitions will include tangible products or certain types of products. For example, some states charge sales tax on all products but others may not tax certain types of clothing and food that are considered necessities. Some states subject certain services to sales tax as well.
Every state has their own definition of use tax, and it's important to confirm for the states your business is operating in. Use tax may be charged where sales tax was not collected from the purchaser. Use tax can also apply to purchases made out of state or where a purchase would not have originally been taxable but is used in a way that makes it taxable.
If you produce or sell products internationally, you may be subject to other countries tax including value added tax. A value added tax is a consumption tax assessed on products as they go through the supply chain.
Sales tax is incredibly complicated. Always consult professionals if you suspect you owe sales tax or to confirm you do not.
Local sales tax
Most sales tax is collected at the state level. However, local governments can collect sales tax in some places. For example, in Colorado a county can set up its own sales and use tax and if you sell to someone in that county, you are required to collect and remit the appropriate tax.
States without sales tax
There are 5 states that do not collect sales tax. They can be remembered by the acronym NOMAD: New Hampshire, Oregon, Montana, Alaska, Delaware.
If you are selling online, consider using a service or platform that assist with computing, collecting and remitting sales tax such as:
Ultimately it is the business and owners responsibility to ensure the proper sales tax is paid, so if you outsource this process, you still need to oversee it. It is a good idea to consult with a tax professional experienced with sales tax in multiple states.
In the US taxpayers owe two main types of income-based tax to the federal government and one type to the state. To the IRS we pay 1) social security and medicare tax, known as payroll tax for employees and self-employment tax for self-employed business owners and 2) income tax, which is based on your income tax bracket. To each state, we pay income tax if that state has an income tax. This section will focus mainly on state income tax. See these additional blogs for more information:
You are likely noticing a theme by now: states create all their own tax rules. This is no different when it comes to state income tax.
Employee tax withholding
When you have employees, you have to withhold and remit tax for them, to represent all or a portion of the tax they will eventually owe at tax time. If your employees are working or live in multiple states, you may need to register as an employer in each of those states.
As a general rule, you need to remit tax where your employee lives and works. If they live and work in two different states, you need to ensure you know where the tax is to be paid. If your employee moves to another state, you will have to update their tax withholding according to the new state rules.
States with reciprocal agreements
Federal law prohibits two different states from collecting income tax from the same taxpayer. Some states have reciprocal agreements that clarify which state will get the tax. Usually this means that if your employee lives in one state and works in another, they only need to pay tax where they live, and you as the employer will only withhold tax and remit it to their state of residence. For example, Arizona has a reciprocal agreement with California. If an employee lives in California and works in Arizona, a form can be filed with Arizona to not withhold Arizona state tax. The employer then only withholds and remits California state income tax for the employee.
There are many articles and blogs that explain which states have reciprocal agreements and your payroll processor can help. Keep in mind the laws can change in any state at any time, and so these lists can become out of date. Confirm the existence or lack of a reciprocal agreement with your tax professional or current payroll processor.
- Patriot: Which States Have Reciprocal Agreements
- Gusto: Reciprocal agreements
- Squareup: Payroll Reciprocal State Agreements
- Zenefits: What is a Reciprocity Agreement?
No reciprocal agreement
If there is no reciprocal agreement, you have to figure out where the employee is likely going to owe the tax and set the withholding accordingly. It will likely be the state they are physically working in, but not always.
If your employee travels and works in multiple states, and there is no reciprocal agreement, you may have to remit tax to the state they are physically located in while performing the work even if this constitutes a different state each week or many states over the course of the year. This also means tracking their hours by location and registering as an employer in each state work is conducted.
Remote work rules are less clear. Due to the pandemic states and the US federal government are looking at rules to clarify where income tax is paid including for remote work. In some cases you may be in the uncomfortable position of having to guess where the tax will be due. Consult a tax professional to help make this determination.
Business owner income tax
In addition to determining where your employees need to pay tax, you also have to determine where your income will be taxed. If you operate businesses in multiple states, it could be where you are physically located or based upon each business location.
A tax professional can research the rules for each state and make this determination based on the current state laws. You generally do not have to have a separate tax professional in each state. It is best to choose a tax professional who will have the most knowledge of the most important or most complicated state rules. Therefore, if you are conducting business in more than one state consider these factors when choosing where to find a tax professional.
- Most complicated state. Consider if one of the states have very complicated tax structures. If you are operating in CA or NY, for example, choose a tax professional who will know those laws well, as someone out of state might not understand the complexities.
- State with income tax. If one of the states you are operating in has no state income tax, choose a tax professional where there is state income tax. For example, if your business is in Florida and Georgia, choose a tax professional in Georgia since Florida has no state income tax. It will cost less to have someone in Georgia explain Georgia rules than to have someone in Florida learn Georgia rules.
- Largest income source. Consider consulting a tax professional where you are earning the most income. For example, if you earn most of your income in Illinois and have a small office operating in Missouri, consider consulting a tax professional in Illinios.
States without state income tax
There are nine US states without income tax:
If you are considering expanding into a new state, look at one of these states as an option to avoid the complicated question of whether you may have to pay a portion of your personal income tax or remit employee tax withholding to the state. However, keep in mind even if there is no income tax there can still be business taxes and fees, for example a gross receipts tax as mentioned above.
Operating your business in multiple states is more complicated that operating in one state. It may suit your business to expand across state lines or across the country, and you may have little choice if your valued employee who can work remotely, decides to move. Because this topic can be so overwhelming, take each type of tax above one at a time, do some research on your own and then consult with a professional and attorney to ensure your understanding is correct. Once you have established yourself and learned the rules, it won't be as complicated as it initially seems.
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