The taxes of LLCs are significantly less complicated than that of corporations. Nonetheless, you should never enter a new corporate entity without first thoroughly comprehending its tax ramifications. It only makes sense if you want to know how to form a LLC, to first look at the most appropriate state.
Before comparing the US states for LLC formation with regards to corporate tax, it is important to know that tax is reported and paid on three levels. These levels include federal, state and local income tax. Federal income tax is imposed by the Internal Revenue Service (IRS) on the yearly income of a taxpayer, business or any legal entity.
This kind of tax is broken down into certain brackets, where entities are divided according to their income. Therefore, you pay federal tax based on the bracket you fall into. State income tax works a little differently. A business or entity pays state income taxed based on the state they are conducting business in. There is no flat rate for state income tax, due to the fact that the amount varies from state to state, but the rate is much less than federal income tax. Lastly we have local income tax. This type of tax is imposed by individual municipalities in order to fund local services like garbage collection and sewer maintenance.
This leads to the following question: When analyzing corporate tax, which US state is the best for LLC formation? In answering the question “What's The Best State to Form Your LLC in?” by TRUiC, the various states are compared. Below we will discuss, with regards to corporate tax, how the following states differ.
Nevada
Federal Income Tax
The LLCs situated in Nevada can be described as “tax-reporting” entities, rather than “tax-paying”. This means that these LLCs are not required to do their own tax return filing, but rather to file their profits and losses through the owner’s personal income. The IRS will tax the LLC based on the amount of owners it has. For example, if the LLC has one owner it will be taxed as a Sole Proprietorship and if it has two or more owners it will be taxed as a Partnership.
State Income Tax
When it comes to state tax for LLCs in Nevada, just like with federal tax, they do not pay the tax, but rather report it. This can be done either personally by the owner or done via the corporation. As mentioned above, you pay, or rather report, state tax in the state your business is situated in, according to the State of Nevada Department of Taxations’ Filing Requirements. If the owner lives in California, but the LLC is in Nevada, whether it is done personally or via corporation, the tax will apply to Nevada.
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Local Tax
The various Nevada cities or counties may impose certain local taxes on the LLC. When starting an LLC in a certain city or county, make sure to contact the local official in order to familiarise yourself with the liable taxes.
Wyoming
Federal Income Tax
In Wyoming LLCs are required, same as in Nevada, to report their income and losses on their personal 1040 tax return to the IRS. When doing tax filing the business should specify their owner status. If you are a single owner you are taxed as a Sole Proprietorships and if there is more than one owner, you are taxed as a Partnerships.
State Income Tax
The state of Wyoming is one of the seven US states that does not impose personal income tax. This luckily means that the members of a LLC in Wyoming are not required to file a state-level return. This state has many advantages when it comes to tax, it is quite lenient. Wyoming does not place tax on capital gains, income earned in other states or on retirement income.
The one thing this state does well impose tax on is sales. The state of Wyoming places a total of 4% tax on sales and they have the right to add an additional 2%.
Local Tax
As mentioned above, local taxes vary from state to state. The amount of local tax varies from state to state as well as business type.
Delaware
Federal Income Tax
The state of Delaware works a little differently. Even though LLCs in Delaware are also not required to pay federal and state tax, LLCs in this state are in fact required to pay a flat tax rate of $300 every year. Aside from the annual $300, the income of the business is divided in accordance to the total owners and taxed accordingly.
State Income Tax
There are different tax return forms to be filed for owners that live in Delaware and owners that live in other states. If the LLC is a Sole Proprietorship and the owner lives in Delaware Form 200-01 needs to be filed and if the owner is from another state, Form 200-02 needs to be filed. In the case of a Partnership, tax Form 300 and Delaware Schedule K-1 needs to filed.
The LLC University writes in many of their educational articles that “taxes are paid where income is made”. This is the most important fact to remember. It is best to form your LLC in your home state. Forming an LLC in a different state can cause a lot of headaches, not to mention the additional costs. Your LLC's earnings will be taxed in some form, and now you know how to prepare so you'll be ready come tax season.