Navigating State and Local Tax Obligations for New Business Startups
State and local business requirements depend on your location and business structure, such as sales and income taxes. Furthermore, be sure to maintain any necessary licenses, permits or certificates required by your business.
Tax implications will play a vital role in your startup business, from whether or not to pay income or sales tax and any applicable nexus rules that trigger such taxes.
Location
Beginning a business venture can be daunting. It requires capital, talent, and careful planning in order to meet all legal requirements. Furthermore, where and how the company is structured can have significant effects on tax liability.
An early-stage startup’s location will depend heavily on its operations: online, at home/office space or a storefront. The choice may also depend on what products or services the business provides – for instance a virtual reality hardware company might require physical stores so customers can enjoy an immersive experience.
Structure plays an integral part in determining which federal regulations are relevant. A sole proprietorship may be more suitable for founders seeking to reduce personal liability; alternatively, partnerships can benefit from having multiple people share ownership and responsibility. Filing as either an S corporation or C corporation also impacts how income taxes and other fees are calculated.
Corporate Income Tax
State-level corporate income taxes (CIT) are levied on profits that result from subtracting revenue from costs; currently the United States boasts one of the highest statutory CIT rates globally at 35%.
More startups are opting out of paying CIT by structuring their businesses as pass-through entities such as sole proprietorships, partnerships, LLCs and S corporations. While such structures don’t face federal taxation, their owners must still report their shares of profits on individual income tax returns.
Business tax issues can become especially challenging for startups with multiple locations. With more states adopting sales taxes on SaaS transactions, it is becoming increasingly important for startup entrepreneurs to conduct state-level nexus studies to determine their tax obligations – this helps avoid surprises or costly audits while helping startups manage cash flow more effectively.
Employment Taxes
Operating a business can be both rewarding and costly. Cash flow issues are frequently listed as the number one reason for startup failure in the US; savvy entrepreneurs know to search out tax credits that may help keep their operations afloat while seizing opportunities that arise.
State employment taxes differ by jurisdiction and can include withholding for employee income, employer and worker contributions to Social Security and Medicare, federal unemployment taxes and estimated taxes due if enough withholding amounts haven’t been taken from paychecks, or their filing threshold has been reached due to other filing status (e.g. sole proprietorship or partnership).
Eligible startups may qualify for the research and development credit, which covers costs incurred when creating or improving products, processes or services; conducting experiments; trial-and-error; scientific activities etc. However wages paid directly to owners do not qualify for this deduction.
Sales Tax
Sales tax represents an essential source of state and local revenue, but unlike income taxes which are collected and remitted from all sources of business income, sales taxes are only collected and remitted by businesses selling products or services directly to end consumers.
Most states that have general sales taxes now require “marketplace facilitators,” like Amazon, to collect and remit state sales taxes on behalf of third-party retailers. This requirement was instituted following a recent Supreme Court ruling in South Dakota v. Wayfair that expanded the definition of sales tax nexus beyond physical presence or property ownership alone.
Startups must understand when and how they may become subject to sales taxes in each of the states in which they conduct business, so a knowledgeable startup accountant should conduct an ongoing sales tax nexus analysis as their business develops.
