Not only do taxes affect your business's bottom line, but they can play a role in the economic and employment growth of an area. Gauging the best and worst states for small business taxes can help you determine the best place to start your business.
To help with this, the Tax Foundation’s State Business Tax Climate Index ranked states according to how well their tax systems are structured.
As you might imagine, ranking the states was not an easy feat, given that each of the 50 states has different tax systems. To conduct the analysis, states were compared based on more than 100 variables in five major categories:
- Corporate Taxes
- Individual Income Taxes
- State Taxes
- Unemployment Insurance Taxes
- Property Taxes
Best States for Taxes
According to the Index, the top 10 states for taxes are:
3. South Dakota
6. New Hampshire
According to the Tax Foundation's analysis, many of the top 10 states for taxes share the absence of a major tax. What’s more, Wyoming, Nevada and South Dakota have no corporate or individual income tax (note: Nevada has gross receipts taxes). Alaska doesn’t have individual income or sales tax at the state level, and there’s no individual income tax in Florida. Oregon, New Hampshire and Montana have no sales tax.
Logan Allec, a CPA and founder of Money Done Right, was surprised that Texas didn’t make the top 10 states for taxes. “For one thing, Texas levies no personal income taxes, which is a boon for sole proprietors and pass-through business owners. It does have a margin tax on businesses, but your business isn't on the hook for this unless it has more than $1,130,000 in annual Texas gross receipts for 2019, meaning that many small business owners will essentially pay no state-level tax on their business income. ... For small services-based businesses, Texas is great."
Worst States for Taxes
According to the Index, the 10 worst states for taxes are:
48. New York
50. New Jersey
What do these states share? According to the Index, non-neutral, complex taxes with comparatively high rates. Case in point: New Jersey has some of the highest property tax burdens in the country. Due to recent changes, the "Garden State" ranks second when it comes to the highest corporate income tax rate in the country. It also levies an inheritance tax and has some of the nation’s worst-structured individual income taxes.
Allec felt a bit torn to see Ohio ranked as one of the worst states. “If you're in a low-margin business, then Ohio's 0.26% CAT [Commercial Activity Tax] — which is assessed on gross receipts, not net income — can be a real bear,” says Allec. “But if you have high profit margins, it may not be so onerous.”
Best States to Start a Business
The Climate Index is a good place to start when trying to figure out where to locate your business. In Allec’s opinion, the Climate Index looks more geared toward small businesses taxed as sole proprietorships or S Corporations than larger businesses structured as C Corporations.
“For instance, I was surprised that Oregon made it in the top 10 given that it has a relatively high corporate tax rate of 6.6% on the first $10 million of corporate income and 7.6% thereafter,” says Allec. “That said, I think the ‘best states’ in this list are solid from a small business perspective.”
According to the Tax Foundation's analysis, taxes can impact job creation and retention, business location and a company’s profitability. If taxes take a larger chunk of the profits, that cost is passed along to either consumers, employees, its shareholders or some combination of these.
As you might imagine, a state with lower taxes will be more appealing to businesses. In turn, that state will be more likely to experience economic growth.
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