“In this world, nothing can be said to be certain except death and taxes.” – Benjamin Franklin
Taxes are an unavoidable cost of doing business. No one enjoys the amount of labor involved in calculating taxes. Still, it is both a legal requirement and a duty businesses assume in exchange for the significant assistance society provides its people and businesses alike.
However, as an entrepreneur, you can ensure that you find the best ways to cut your expenses, take advantage of tax breaks or deductions when possible, file your taxes correctly and stay away from audits and fines.
As a business, the first step toward survival and growth is understanding your federal, state, and local taxes. All businesses are required to pay business taxes, but the taxes you must pay and how you pay them depends on the sort of organization you own. They also depend on where your business is located in the United States. These rules vary between states and can change often based on congressional rulings. Hence, it is important to keep track of the federal tax code and comprehend the extent of your tax obligations. More importantly, before investing in a business, check out the best states for business taxes in the U.S.
In this article, we will break down the different categories of business taxes entrepreneurs need to know about. We will look at the most business-friendly states in the U.S. and those that ranked at the bottom of the list in 2023.
The Primary Categories of Business Taxes
While individuals are primarily concerned with federal and state income taxes, businesses also need to consider other tax categories. Though the combination and percentage of taxes levied will vary in different states, the primary categories of business taxes are as follows:
1. Income Tax
All businesses, except for partnerships, must file an annual income tax return. The form you use will depend on how your company is set up. A pay-as-you-go tax is the federal income tax. You must pay the tax as you earn or receive money during the year. Typically, an employee’s compensation has income tax deducted from it. You may need to pay approximated tax if you do not pay your taxes through withholdings or if you do not pay enough that way. If projected tax payments are not required, you can pay any taxes due when you file your return. Some states, like Alaska, Wyoming, South Dakota, Florida, Texas, Nevada, Washington, and Tennessee, do not collect taxes on personal income.
2. Self-Employment Tax
The social security and Medicare taxes largely applied to those who work for themselves is known as the self-employment tax (SE tax). Your social security benefits are influenced by the SE tax payments you make. Retirement benefits, disability benefits, survivor benefits, and hospital insurance (Medicare) benefits are all provided through social security coverage.
Generally, if one of the following applies, you must pay SE tax and submit Schedule SE (Form 1040 or 1040-SR).
- If your self-employment net profits were $400 or greater.
- If you work for a qualified church-controlled organization or a church that has chosen to exempt itself from social security and Medicare taxes, you are then subject to SE tax if your employer pays you $108.28 or more in wages (unless you are a minister or a member of a religious order).
3. Employment Taxes
You have various employment tax obligations when you have employees, including payments and documents to complete.
Taxes on employment include the following:
- Social security and Medicare taxes
- Federal income tax withholding
- Federal unemployment (FUTA) tax
4. Excise tax
If you do any of the following, you may be required to pay excise taxes:
- Produce or market-specific goods
- Run specific commercial ventures
- Utilize a variety of tools, resources, or goods
- Obtain compensation for specific services
Considering the variation in taxation regulations, entrepreneurs must evaluate the laws to choose the best states for business tax.
What Makes a State Tax-Friendly for Businesses?
As an entrepreneur, the taxes you pay to the state are added to your overhead and can eat away at your profits. Hence, entrepreneurs will always look for ways to lower their business taxes and keep their companies profitable. In the US, different states have different tax regulations. Hence when entrepreneurs want to set up a new business or move their business location, they tend to choose states that are tax-friendly for businesses. These are the states that have the lowest tax rates.
Whether you are an employee or an entrepreneur, you’re probably not going to pick up and move simply to avoid state and local taxes. There are simpler ways to cut your tax bill, like saving for retirement, calculating business expenses, and taking advantage of education credits and deductions.
Top 10 Best States for Business Taxes
An independent tax research organization headquartered in Washington, D.C., the Tax Foundation released its annual report, the State Business Tax Climate Index for 2023, which ranks state tax regimes. This helps small business owners and entrepreneurs make the best choice possible when they want to set up new businesses or change the location of their existing companies. The Index provides a bird’s eye view of how different states structure their business taxation systems, providing a road map for improvement if required.
| State | Corporate tax, rank | Individual income tax, rank | Sales tax, rank | Property tax, rank | Unemployment insurance tax rank | State-Specific Benefits |
|---|---|---|---|---|---|---|
| Wyoming | 1 | 1 | 6 | 34 | 28 | No corporate or individual income tax. |
| South Dakota | 1 | 1 | 34 | 14 | 37 | No corporate or individual income tax. |
| Alaska | 28 | 1 | 5 | 26 | 44 | No state-level sales tax. |
| Florida | 10 | 1 | 21 | 12 | 3 | No individual income taxes. |
| Montana | 22 | 24 | 3 | 21 | 18 | High proportion of college graduates in the labor market. No state-level sales tax. |
| New Hampshire | 44 | 9 | 1 | 43 | 45 | Generous government resources. No sales tax. Residents earn more per person. |
| Nevada | 25 | 5 | 44 | 5 | 46 | No corporate or individual income tax. |
| Utah | 14 | 10 | 22 | 8 | 16 | Greatest approval rate for small business loans. |
| Indiana | 11 | 15 | 19 | 2 | 27 | Ranks as the best state to start a business due to low taxes + reasonable cost of living. |
| North Carolina | 5 | 17 | 20 | 13 | 10 | A 14,581 net increase in the number of new businesses since 2020. |
States that rank higher in these studies often have one thing in common – they lack a significant business tax, which greatly improves their overall score. While every state imposes property and unemployment insurance taxes, some do not levy a corporate or individual income tax, like Nevada, South Dakota, or Wyoming. Similarly, no state-level sales taxes are levied in Alaska, New Hampshire, or Montana, while no individual income taxes are levied in Florida or Tennessee.
According to Forbes, many other states also have distinct advantages over others. For example, due to their business-friendly policies,
- Washington has a year-to-year business survival rate of 89%, which is the highest in the country.
- Texas has an increasing number of IT, energy, and healthcare businesses that apply for business licenses annually, leading to a net increase in new businesses of 15,656 since 2020.
- Kentucky has the lowest business formation fee in the US, at just $40, encouraging entrepreneurs to set up new companies.
The quality and quantity of the workforce also play an important role in business survival. With over 40% of their workforce having a college degree, Massachusetts, Colorado, and Connecticut are poised for success. Meanwhile, California, Alaska, and Colorado boast the largest working populations.
Top 10 Worst States for Business Taxes
The Tax Foundation also releases a list of the worst states for business taxes every year, which revealed results for 2023 included in the table below:
| State | Corporate tax, rank | Individual income tax, rank | Sales tax, rank | Property tax, rank | Unemployment insurance tax rank | Most Prohibitive Disadvantage |
|---|---|---|---|---|---|---|
| Alabama | 18 | 30 | 50 | 18 | 19 | Strict business compliance regulations |
| Rhode Island | 40 | 33 | 24 | 41 | 49 | Shortest average work week |
| Hawaii | 19 | 46 | 27 | 32 | 30 | Low business survival rate |
| Vermont | 41 | 39 | 17 | 48 | 17 | High business start-up costs |
| Minnesota | 43 | 43 | 29 | 31 | 34 | High corporate tax rate |
| Maryland | 33 | 45 | 30 | 42 | 41 | High labor costs |
| Connecticut | 27 | 47 | 23 | 50 | 23 | Regulatory obstacles |
| California | 46 | 49 | 47 | 19 | 24 | High overhead expenses |
| New York | 24 | 50 | 43 | 49 | 40 | High costs of living |
| New Jersey | 48 | 48 | 42 | 45 | 32 | High corporate tax rate |
In addition, Forbes noted that some states struggled to maintain healthy business growth. For example,
- New York, with a high cost of living, high unemployment rate, and a relatively low business survival rate of 79%, saw the largest decrease in business, with 3,550 fewer businesses in 2021 than in 2020.
- Hawaii has the lowest business survival rate at just 75%.
- Startups in Massachusetts have to shell out the most cash to get started, with the highest formation fee across the nation at $500.
The states at the bottom of the list usually have complex, non-neutral taxes with comparably high rates. For instance, New Jersey has some of the nation’s highest property tax, the highest corporate income taxes, some of the highest individual income taxes, a particularly harsh approach to treating foreign income, an inheritance tax, and some of the worst structured individual income taxes.
The Best States to Launch a Business
Taxes affect a company’s profitability, the location of a business, and the creation and retention of jobs. If taxes eat a higher portion of profits, the expense is transferred to customers, staff, shareholders, or a mix of these parties. As you might expect, businesses are more drawn to states with lower taxes.
According to Forbes, the list below includes the top states to launch a business in 2023.
- Business costs: They evaluated the expenses incurred to establish and operate businesses in the state.
- Business climate: They examined the economic environment surrounding industries, which included the government and political attitude toward labor organizations, and their financial stability.
- Financial accessibility: They determined whether entrepreneurs or companies could avail of financial services easily. The evaluated factors included credit, loans, insurance, and other risk management services.
- Economy: They evaluated factors like consumer behavior, rate of growth and development, inflation, interest, and unemployment rates, to get an overall picture of economic conditions that could affect businesses in these regions.
- Workforce: They analyzed the level of education across the workforce-age population, determining which states had the highest number of skilled or trained workers available for local hiring.
| Rank | State | Business Costs | Business Climate | Financial Accessibility | Economy | Workforce | Total Weighted Score | Score out of 100 |
|---|---|---|---|---|---|---|---|---|
| 1 | Indiana | 9 | 7 | 9 | 4 | 3 | 32 | 100 |
| 2 | Colorado | 8 | 7 | 6 | 5 | 5 | 31 | 98 |
| 3 | North Dakota | 7 | 3 | 10 | 5 | 5 | 30 | 96 |
| 4 | Pennsylvania | 6 | 7 | 9 | 4 | 3 | 30 | 94 |
| 5 | South Dakota | 6 | 6 | 10 | 4 | 4 | 29 | 92 |
| 6 | North Carolina | 7 | 8 | 6 | 3 | 4 | 29 | 90 |
| 7 | Montana | 8 | 6 | 7 | 4 | 4 | 29 | 88 |
| 8 | Illinois | 4 | 8 | 8 | 5 | 4 | 29 | 86 |
| 9 | Ohio | 8 | 6 | 7 | 4 | 3 | 29 | 84 |
| 10 | Delaware | 8 | 6 | 8 | 5 | 1 | 28 | 82 |
According to a study that evaluated several federal and state government reports, independent studies, and responses from real business owners from all over the US, the states that make it most feasible to launch a startup include:
| State | Most Business-Friendly Feature |
|---|---|
| Texas | Best overall for starting a new business |
| Utah | Best for Business Financing |
| Montana | Best for Business-friendly Policies |
| Georgia | Best for Cost of Labor |
| Florida | Best State for Starting a Business for Tax Purposes |
| California | Best for Innovation |
| Oklahoma | Best for Cost of Doing Business |
| Idaho | Best for Real Estate |
| North Carolina | Best for Starting an LLC |
| Delaware | Best for Privacy Protection |
Conclusion
The state and local taxes you pay annually can significantly impact your company’s financial health. They affect the expansion of employment and the local economy in your company’s area. Due to the marked differences in taxation across various states, you may find it challenging to decide where to register your business or change locations if needed. As a result, it’s critical to understand the taxes you must pay as a business owner and ask for expert advice when you need it!
Disclosure
To ensure compliance with requirements imposed by the IRS, we hereby inform you that any information contained in this blog is not intended or written to be used, and cannot be used, for the purpose of avoiding tax-related penalties under federal, state, or local tax law.
