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A Guide to U.S. Corporate State Taxes

Taxation

A State Tax Guide for Non-Resident Business Owners


A State Tax Guide for Non-Resident Business Owners - Many of our clients are unaware of this fact, but there are no citizenship or residency requirements to form an LLC or C-corporation in any U.S. State. Non-U.S. residents can form businesses in the U.S. and have been doing so for a very long time, there are a multitude of reasons and benefits in doing so, such as the obvious one of gaining access to the largest integrated economy in the world.

But when it comes time to form a business in the U.S. as a non-resident, choosing which State to set your company up in can have real consequences. This white-paper aims to present some of the leading issues associated with State taxation and compares 3 of the most popular States and looks at their position on corporation taxation and how it might impact your business.

What is a Non-Resident Alien for tax purposes?

By definition, non-resident aliens do not reside in any U.S. State or territory. Non-resident aliens also have the right to set up a business in any of the 50 States of the United States, plus the District of Columbia and US territories. An alien (per the IRS definition) is any individual who is not a U.S. citizen or U.S. national. A nonresident alien is an alien who has not passed the green card test or the substantial presence test.

Tax treatment of Nonresident Alien

If you are a nonresident alien engaged in a trade or business in the United States, you must pay U.S. tax on the amount of your effectively connected income, after allowable deductions, at the same rates that apply to U.S. citizens and residents.

See Alien Taxation – Certain Essential Concepts for a summary of some rules that apply to resident and nonresident aliens.

Picking the right U.S. State for your company

In terms of picking the right State for your business, there is no simple answer as to which State is the best fit. If you are a non-U.S. citizen or a non-U.S. resident, selecting the State that is best for your business comes down to how the business is run and what types of products and services you might be offering and where any services might be performed.

Generally speaking, if you’re going to have an office, employees, or physical presence in the U.S., then you should form your business in that State. This is the State where your company will be transacting business and paying salaries to residents of that particular State so this makes clear sense.

However, If your business will have no physical presence in the U.S., as is the case with many of our clients who perhaps operate an ecommerce, technology or service based business from outside the country but may have U.S. based clients, then you can really choose any State in which to form your U.S. company. Which state you choose can have impacts on your tax liability and annual compliance upkeep and should be considered carefully prior to launching your U.S business endeavor.

Before picking which State makes sense you should first understand your own business, how it will operate in the U.S. and what the State tax obligations are in the States that interest you.

Determining a State established “nexus”

It can at times seem complex to determine State corporate tax law, especially when attempting to understand tax obligations where you have a business with clients all over the United States. Generally there are a few principles which help understand this determining, or as its referred to in State law, a “nexus”.

States must first establish whether a company has “nexus” in the state, that is, enough physical or economic presence to owe tax. Next, they must determine the taxable income generated by activities in the State. For example, multistate companies often have subsidiaries in no-tax or low-tax states that hold intangible assets such as patents and trademarks. The rent or royalty payments to those wholly owned subsidiaries may or may not be considered income of the parent company operating in another State. States must determine how much of a corporation’s taxable income is properly attributed to that state.

Until 20 years ago, most states used a three-factor formula based on the Uniform Division of Income for Tax Purposes Act to determine the portion of corporate income taxable in the state. That formula gave equal weight to the shares of a corporation’s payroll, property, and sales in the state. Now, however, most states use formulas that either weight more heavily or rely exclusively on sales within the state to apportion income.

In 2020, only five states used the traditional three-factor formula, while 26 states and the District of Columbia relied exclusively on sales in their formula. By using the portion of a corporation’s sales rather than employment or property to determine tax liability, states hope to encourage companies to relocate or to expand their operations within these states.

So, which State to form a company if you are a non-resident alien?

There is no definitive answer to this question, as it depends entirely on your business model as to whether your business is operating in tangible goods within a jurisdiction or in-tangible products and services that are not effectively connected with a state.

Non-resident aliens want to avoid any appearance of a “nexus” of their personal activities and their business activities in any state. But usually, the best state for forming a U.S. company, if you are a non-resident alien, is the state with the lowest fees, so lets look into those factors by first evaluating the different types of taxes that you or your business may or may not be impacted by.

Corporate income taxes are levied in 44 states. Though often thought of as a major tax type, corporate income taxes account for an average of just 3.38 percent of state tax collections and 2.24 percent of state general revenue.

Iowa levies the highest top statutory corporate tax rate at 12 percent, followed by New Jersey (11.5 percent), Pennsylvania (9.99 percent), and Minnesota (9.8 percent). Two other states (Alaska and Illinois) levy rates of 9 percent or higher. Conversely, North Carolina’s flat rate of 2.5 percent is the lowest in the country, followed by rates in North Dakota (4.31 percent) and Colorado (4.63 percent). Four other states impose rates at or below 5 percent: Arizona (4.9 percent), Utah (4.95 percent), and Kentucky, Mississippi, and South Carolina (5 percent).

Nevada, Ohio, Texas, and Washington forgo corporate income taxes but instead impose gross receipts taxes on businesses, generally thought to be more economically harmful due to tax pyramiding and non-transparency.

Delaware imposes gross receipts taxes in addition to corporate income taxes, as do several states, like Pennsylvania, Virginia, and West Virginia, which permit gross receipts taxes at the local (but not state) level. South Dakota and Wyoming levy neither corporate income nor gross receipts taxes.

Thirty-four states and the District of Columbia have single-rate corporate tax systems. The greater propensity toward single-rate systems for corporate tax than individual income tax (11 states) is likely because there is no meaningful “ability to pay” concept in corporate taxation. A single-rate system minimizes the incentive for firms to engage in economically wasteful tax planning to mitigate the damage of higher marginal tax rates that some states levy as taxable income rises.

Key Findings

• Forty-four states levy a corporate income tax. Rates range from 2.5 percent in North Carolina to 12 percent in Iowa.
• Six states—Alaska, Illinois, Iowa, Minnesota, New Jersey, and Pennsylvania—levy top marginal corporate income tax rates of 9 percent or higher.
• Eight states—Arizona, Colorado, Kentucky, Mississippi, North Carolina, North Dakota, South Carolina, and Utah—have top rates at or below 5 percent.
• Nevada, Ohio, Texas, and Washington impose gross receipts taxes instead of corporate income taxes. Gross receipts taxes are generally thought to be more economically harmful than corporate income taxes.
• South Dakota and Wyoming are the only states that do not levy a corporate income or gross receipts tax.

Notable Corporate Income Tax Changes in 2020-2021

Several states implemented corporate income tax rate changes over the past year, among other revisions and reforms. Notable changes for 2020 include:

• Florida’s corporate income tax rates were set to revert to the 2018 rate of 5.5 percent, but legislation was enacted to extend the 2019 rate of 4.458 percent to 2020 and 2021.
• As part of a 2018 tax cut package following federal reform, Georgia lowered its top corporate income tax rate from 6 percent to 5.75 percent and doubled the standard deduction. A further reduction to 5.5 percent is scheduled for 2020, pending legislative approval.
• Indiana’s rate decreased to 5.5 percent on July 1, 2019, and a further reduction to 5.25 percent is scheduled to kick in July 1, 2020.
• Mississippi continued phasing out its 3 percent corporate income tax bracket by exempting the first $3,000 of income this year. The 4 and 5 percent brackets remain in place.
• Missouri lowered its corporate income tax rate from 6.25 to 4 percent, paying down this reduction by no longer giving companies the option of choosing the apportionment formula most favorable to them.
• New Jersey’s temporary surcharge decreased from 2.5 to 1.5 percent, bringing the state’s top rate to 10.5 percent instead of 11.5 percent.

So, which State to form a company if you are a non-resident alien?

As we stated above, there is no definitive answer to this question, as it depends entirely on your business model as to whether your business is operating in tangible goods within a jurisdiction or in-tangible products and services that are not effectively connected with a state.

Non-resident aliens want to avoid any appearance of a “nexus” of their personal activities and their business activities in any state. But usually, the best state for forming a U.S. company, if you are a non-resident alien, is the state with the lowest fees, so let’s look into those factors by first evaluating the best and the worst states for setting up a business as a non-resident.


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