Your corporation or LLC will have to pay any required business income taxes in any applicable state in which your company transacts business in addition to any required franchise taxes.
Business Income Taxes
Most states (47) charge corporate income taxes for income derived in that state, or “source income.” Businesses organized in states outside states the business conducts business in will be subject to income tax only on income earned in that state(s) or apportioned to the state(s). Since the income/loss of an LLC is on the owner’s personal tax return, most states do not tax the LLC owner separately for the income from the LLC. This income is subject to state income tax in the same way as other owner income or salary/wages.
Your business may be liable for corporate (and sometimes LLC) income taxes by organizing or registering to do business in a foreign state. California, for instance, imposes an entity income tax on any LLC that earns more than $250,000 based on gross receipts from all income generated in the state. (S corporations that are doing business in California must pay a 1.5% net income tax). California also charges a minimum flat franchise tax to all LLC’s that organize in California, registers in California, conduct business in California, or receive California source income. Illinois imposes a 1.5% personal property replacement income tax on all S corporation and LLC business income derived in the state of Illinois. Most states impose a flat corporate tax rate on all business income earned in that state.
However, a handful of states do not impose income taxes, posing a factor to keep in mind if you ever decide to organize or re-organize away from your “home” state. States such as Nevada do not impose any corporate or LLC income tax on income derived in the state. These are the states that have been hyped by Internet incorporation services as a spot you should organize your corporation or LLC. Of course, if you’re an Internet business, this may not matter too much since you might be deriving income in multiple states and have enough of a presence in those states to be liable for income taxes. Any alleged tax advantages reaped by organizing the business in a state without corporate income tax are offset by any required income taxes in the state the business is physically located in or where the owners reside.
So, simply organizing away from your home state to avoid corporate or LLC income taxes may not prevent your business from having to pay them at some point. This may hold especially true for Internet based businesses.
Incorporating without getting the advice of your accountant is a bad idea. I routinely advise my clients to talk to their accountant in conjunction with their organization to add the tax input. Your accountant should work in harmony with your business attorney to come up with a strategic plan for your business organization. Even if you let this Guide replace having a live business attorney (if your not using our services), you should strongly consider hiring a qualified accountant to review your business structure and make a recommendation based on taxes, all other things being equal.
Franchise Taxes
A franchise tax is a tax levied by a state for the privilege of either incorporating or qualifying to do business in that state. A franchise tax may be based upon income, assets, outstanding shares, or a combination. Some states, such as Illinois, impose a flat franchise tax on all LLC’s regardless of income, but base their corporate franchise taxes on the paid-in capital of the corporation. Other states impose a franchise tax and corporate income tax (e.g. California imposes a flat $800 franchise tax for LLC’s, but imposes additional income taxes for LLC’s with income exceeding $250,000 as mentioned earlier).
Some states impose a significant franchise tax while other states, such as Nevada have no franchise tax. Typically states that impose higher corporate income taxes usually have low franchise taxes. The amount of the franchise tax and the method of calculation can usually be found on the secretary of state, or similar department, website of each state.
Again, the important point to take away is that your business may be liable for franchise taxes if it has to qualify to do business elsewhere. So, this isn’t exactly the best reason to pick a state like Nevada to organize your business.
TIP! If you incorporate in a state that bases it franchise taxes on paid-in capital (such as corporations in Illinois and other states), the higher this amount is, the higher the franchise tax. Paid in capital refers to the capital contributed to a corporation by the owners through purchase of stock from the corporation. It refers to capital stock (shares issued), as well as additional paid-in capital.