Are You a Small Business and Taxed at the State Level?

For the last several years, state and local government taxes have been going up. Washington, D.C., for example, has seen sales taxes hike from 4% to 5%, as well as city income taxes increase by a comparable amount. These increases have not been limited to taxes paid by businesses. Individuals have seen a similar trend, with state income tax rates increasing from 4.9% to 5.9% and city rates increasing from 3% to 5% (in some cases). The result is that more and more small businesses are being taxed at the state level.

State and local taxation can be complicated and intimidating, but it does not have to be. This article will cover several important aspects of state taxation of small businesses, including how to determine your ‘profit’ margin, what records to keep, and what to do if your state taxes are too high. It will also discuss some of the consequences of being taxed at the state level, as well as possible solutions (such as moving to a better-taxed state or forming a union with neighboring entities) to decrease your tax bite.

How To Determine Your Overall Profit Margin

First, it is important to determine your profit margin. What is this measure? It is the total profit you make from the sale of your goods or services before taxes, compared to the selling price of those goods or services. Essentially, it is the income earned before you have to pay any taxes.

If you are selling $100 worth of widgets at $5 a piece, your profit margin would be $100 ÷ $5 = 20%. It is usually good practice to find the profit margin for each product or service that you sell, so you can properly report your income to the IRS and other agencies that may be taxing you. Your profit margin is an important number to have, as it indicates how much more or less you can charge for the product (or service) without risking falling over the profit margin threshold.

Types of Business Taxes

State taxation of small businesses is complicated and varies by state. Some states, like Washington, assess businesses on an annual basis, while others, like Delaware, assess businesses at the end of each fiscal year. Still other states, like New Hampshire, assess only a specific category of business, such as manufacturers, while still others have a mix of annual and fiscal year-end assessments.

Each state’s method of evaluating and taxing businesses varies, but there are some general guidelines that most states follow. First, every state requires that you file a business license (unless you are exempt from doing so), pay taxes on your goods and services sold within the state, and keep certain records. Second, most states impose a gross receipts tax on businesses that exceed a certain threshold (usually around $100,000 in annual sales). Third, most states have a property tax on businesses (sometimes called a ‘real estate tax’ or a ‘real estate surcharge’). Fourth, most states also have an ‘occupation’ or ‘employer’s tax’ which is placed on top of your income tax bill. Finally, many states have an ‘energy cost recovery fee’ which is often charged to businesses that have certain fuel-related equipment, such as heating or cooling systems.

The combination of these taxes makes up your total state tax liability. There are also some states (like California) that have a ‘tenth tax’ on top of all these other taxes. In California, this tax is referred to as the ‘carbon tax.’ It is a flat $25 per month per person, per household. Businesses with more than $500,000 in annual sales are subject to this tax.

How Is My Business Profitable?

If you are just starting a business and looking to determine how much profit you can make, it can be a little difficult. One way to find out is to calculate your profit margin, as mentioned above. However, it is also important to consider other factors. How is my product or service selling? What is my cost of goods/ or services? Your profit margin will be more meaningful if you know how much your product is actually selling for and how much you are spending on each unit of that product or service.

For example, if you are running a flower shop and you want to know how much profit you can make from selling $100 worth of flowers, simply divide the $100 by the number of flowers you sold (in this case, 100). This is your profit margin for that particular product. Do the same for your other products (if you sell different flowers in addition to the ones mentioned above) and add up all of your individual profit margins to find your total profit margin for the business. You can find a similar example using cost of goods.

What Are My Financial Records?

Every business, regardless of size, must keep certain financial records. These records include things like invoices, bills of sale, and inventory. While you may not need to keep every piece of paper that you touch in your business, it is advisable to keep some form of records, especially if you are doing any kind of business with the state or other government agencies. Additionally, many businesses, especially those with larger annual sales, are required to keep certain financial records for a period of five years.

In most cases, the records that you will need to keep include:

  • Invoices
  • Accounts receivable
  • Sales order/Profit and loss statement
  • Bank statements
  • Tax returns

Additionally, many businesses, especially those with annual sales over $1 million, are required to file forms with the federal government called ‘income tax returns.’ These are required to be filed by January 31 of each year.

What Am I Paying In Total?

In most cases, state taxes are calculated separately from federal taxes. However, in some instances, your overall tax bill can include some or all of these extra amounts. In these cases, you will see the IRS, state, and local government tax amounts listed together on your tax bill. This is because the IRS taxes businesses on a federal level and the states tax businesses at the individual level. In some situations, this can result in a double dipping or even a triple dipping of your income tax bill. This can be avoided by filing tax forms separately or paying your taxes in order, as scheduled. The best advice is to consult with a professional tax attorney or CPA who can advise you on the best course of action for your individual situation.

As you can see, state taxation of small businesses is not as complicated as it seems. By understanding some of the basics involved in being taxed in a new state, you can better prepare yourself for the tax man. Additionally, it is often a good idea to consult with a professional who can help you navigate through this often confusing maze.