Maryland State Business Income Tax

What kind of tax will you owe on Maryland business income?

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Most states tax at least some types of business income derived from the state. The details of how income from a specific business is taxed depend in part on the business’s legal form. In most states, corporations are subject to a corporate income tax, while income from “pass-through entities” such as S corporations, limited liability companies (LLCs), partnerships, and sole proprietorships is subject to a state’s tax on personal income. Tax rates for both corporate income and personal income vary widely among states. Corporate rates, which more often are flat regardless of the amount of income, generally range from 4% to 9%, and personal rates, which generally vary depending on the amount of income, can range from 0% (for small amounts of taxable income) to around 9% or more in some states.

Currently, four states (Nevada, South Dakota, Washington, and Wyoming) do not have a corporate income tax, and the same four states, along with Alaska, Florida, and Texas, have no personal income tax. Individuals in New Hampshire and Tennessee are only taxed on interest and dividend income.

Apart from taxing business income through a corporate income tax or a personal income tax, many states impose a separate tax on at least some businesses, sometimes called a “franchise tax” or “privilege tax.” This is frequently defined as a tax simply for the right or “privilege” of doing business in the state. As with state taxes on business income, the specifics of a state’s franchise tax often depend in part on the legal form of the business. Franchise taxes are generally either a flat fee or an amount based on a business’s net worth.

Maryland has a corporation income tax, but no franchise or privilege tax generally applicable to businesses. Also, Maryland taxes pass-through entities—S corporations, LLCs, and partnerships—to the extent that they have nonresident members. For the latter, if income from your business passes through to you personally, that income will be subject to taxation on your personal state tax return.

Maryland’s corporation income tax is assessed at a flat rate of 8.25% of net income. Pass-through entities with nonresident members are taxed on those members’ distributive or pro-rata shares of the entity’s income allocable to Maryland. Nonresident members may be individuals (persons or fiduciaries) or entities. The tax rate for income allocable to individuals is 7.5%, and the tax rate for income allocable to entities is 8.25%.

Let’s briefly look at additional details for five of the most common forms of Maryland business: corporations (C corporations), S corporations, LLCs, partnerships, and sole proprietorships.

Corporations. Maryland corporations are subject to Maryland’s corporation income tax at the flat rate of 8.25% of net income.

Example: For the latest tax year, your Maryland corporation had $100,000 of net income. Your corporation will owe Maryland corporation income tax in the amount of $8,250 (8.25% of net income).

S Corporations. An S corporation is created by first forming a traditional corporation, and then filing a special form with the IRS to elect “S” status. Unlike a traditional corporation, an S corporation generally is not subject to separate federal income tax. Rather, taxable income from an S corporation passes through to the individual shareholders, and each shareholder pays federal tax on his or her share of that income on his or her individual federal tax return. In other words, with respect to federal taxation, S corporations are “pass-through” entities. (Note that a shareholder’s share of the S corporation’s income need not actually be distributed to the shareholder in order for the shareholder to owe tax on that amount.)

Maryland is unusual in that it requires S corporations to pay income tax on income allocable to nonresident shareholders. More specifically, income allocable to nonresident shareholders who are individuals is taxed at 7.5%, and income allocable to nonresident shareholders that are entities is taxed at 8.25%. In addition, each individual shareholder must pay state tax on his or her share of the corporation’s income.

Example: For the latest tax year, your Maryland S corporation had $100,000 of net income. All corporation shareholders are Maryland residents. Therefore, no entity-level income tax is due. However, the corporation’s net income will be allocated to you and your fellow shareholders, and you will each pay tax on your own portions on your respective state tax returns. The rate for each shareholder will vary depending on his or her overall taxable income for the year.

Limited Liability Companies (LLCs). Standard LLCs are pass-through entities that are not required to pay federal income tax. However, as noted above, Maryland is unusual in that it requires LLCs to pay income tax on income allocable to nonresident members. More specifically, income allocable to nonresident members who are individuals is taxed at 7.5%, and income allocable to nonresident members that are entities is taxed at 8.25%. In addition, each individual LLC member must pay state tax on his or her share of the company’s income.

Also, note that while, by default, LLCs are classified for tax purposes as partnerships (or, for single-member LLCs, “disregarded entities”), it is possible to elect to have your LLC classified as a corporation. In that case, the LLC would also be subject both to Maryland’s corporation income tax.

Example: For the latest tax year, your multi-member LLC, which has the default tax classification of partnership, had taxable net income of $100,000. All LLC members are Maryland residents. Therefore, no entity-level income tax is due. The $100,000 in net income will be divvied up between you and your fellow LLC members, and you will each pay tax on your respective portions on your individual Maryland tax returns. Rates for each member will vary depending on his or her overall taxable income.

Partnerships. Partnerships are pass-through entities that are not required to pay federal income tax. However, Maryland is unusual in that it requires partnerships to pay income tax on income allocable to nonresident partners. More specifically, income allocable to nonresident partners who are individuals is taxed at 7.5%, and income allocable to nonresident partners that are entities is taxed at 8.25%. In addition, each individual partner must pay state tax on his or her share of the partnership’s income.

Example: For the latest tax year, your partnership had net income of $100,000. All partners are Maryland residents. Therefore, no entity-level income tax is due. The $100,000 in net income will be divvied up between you and your fellow partners, and you will each pay tax on your respective portions on your respective, individual Maryland tax returns. Rates for each partner will vary depending on his or her overall taxable income.

Sole Proprietorships. Maryland sole proprietorships are subject neither to Maryland’s corporation income tax nor to the state’s rules regarding nonresident members of pass-through entities. Income from your business will be distributed to you as the sole proprietor, and you will pay tax on that income on your individual federal and state tax returns.

Example: For the latest tax year, your sole proprietorship had net income of $100,000. The $100,000 in net income is distributed to you personally, and you pay tax on that income on your individual federal and state tax returns.

Note on Multistate Businesses and “Nexus”

Our primary focus here is on businesses operating solely in Maryland. However, if you’re doing business in several states, your business may be considered to have “nexus” with those states, and therefore may be obligated to pay taxes in those states. Also, if your business was formed or is located in another state, but generates income in Maryland, it may be subject to Maryland taxes. The rules for taxation of multistate businesses, including what constitutes nexus with a state for the purpose of various taxes, are complicated. If you run such a business, you should consult with a tax professional.

Additional Information

For further guidance on Maryland’s corporation income tax and special rules for pass-through entities with nonresident members, check the Comptroller of Maryland website. For information on business-related taxes in other states, check Nolo’s 50-State Guide to Business Income Tax. And, if you’re looking for detailed guidance on federal income tax issues, check Tax Savvy for Small Business, by Federick Daily (Nolo).

January 2013

 

by: , Contributing Author

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