Most states tax at least some types of business income derived from the state. As a rule, 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.
Pennsylvania has a corporate net income tax, which applies to traditional (C-type) corporations, and capital stock and foreign franchise taxes, which apply to various types of business entities. In addition, if income from your business passes through to you personally, that income will be subject to taxation on your personal Pennsylvania tax return.
Pennsylvania’s corporate net income tax has a flat rate of 9.99% (this makes it one of the highest corporate tax rates in the country). Returns and payments are due on April 15th for corporations with fiscal years that match the calendar year, and 30 days after federal returns are due for corporations with other fiscal years. For purposes of comparison, note that Pennsylvania generally taxes personal income at a flat rate of 3.07%.
Pennsylvania’s capital stock and foreign franchise taxes are a related pair of taxes: the capital stock tax applies to Pennsylvania business entities and the foreign franchise tax applies to non-Pennsylvania business entities. The two taxes are largely identical, and the Pennsylvania Department of Revenue often lumps them together in its publications. We will focus on the capital stock tax because it’s the only one of the two taxes that applies to Pennsylvania businesses. With limited exceptions, the capital stock tax applies to traditional corporations, S corporations, and LLCs, and is based on a business’s “capital stock value” as derived through a special formula involving, among other things, average net income over a five-year period. The first $160,000 of valuation is deductible. The rate for the 2012 tax year is 1.89 mills, and for the 2013 year tax it’s .89 mills.
Let’s briefly look at additional details for five of the most common forms of Pennsylvania business: corporations (C corporations), S corporations, LLCs, partnerships, and sole proprietorships.
Corporations. Pennsylvania corporations are subject to Pennsylvania’s corporate net income tax and to the capital stock tax.
Example: For the 2012 tax year, your Pennsylvania corporation had taxable net income of $500,000. Also, its capital stock valuation was $760,000. The corporation will owe Pennsylvania corporate income tax in the amount of $49,950 (9.99% of $500,000). The corporation will also owe capital stock tax in the amount of $1,134 (first $160,000 in valuation is deductible, leaving 1.89 mills tax on $600,000).
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 is passed through to the individual shareholders, and each individual shareholder is subject to federal tax on his or her share of the corporation’s income. In other words, 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.) Pennsylvania recognizes the federal S election, and Pennsylvania S corporations are not required to pay corporate income tax to the state. However, Pennsylvania S corporations are required to pay the capital stock tax. Also, an individual S corporation shareholder will owe tax on his or her share of the corporation’s income.
Example: For the 2012 tax year, your S corporation had net income of $500,000. Also, its capital stock valuation was $760,000. The corporation will owe Pennsylvania capital stock tax in the amount of $1,134 (first $160,000 in valuation is deductible, leaving 1.89 mills tax on $600,000). Each shareholder will pay tax on his or her individual state tax return on his or her portion of the corporation’s net income at the rate of 3.07%.
Limited Liability Companies (LLCs). Like S corporations, standard LLCs are pass-through entities and, generally speaking, are not required to pay income tax to either the federal government or the State of Pennsylvania. However, Pennsylvania LLCs are required to pay the capital stock tax. In addition, an individual LLC member will owe tax on his or her share of the company’s income.
Also, 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 to Pennsylvania’s corporate net income tax.
Example: For the 2012 tax year, your multi-member LLC, which has the default tax classification of partnership, had net income of $500,000. Also, its capital stock valuation was $760,000. Other things being equal, the LLC will owe Pennsylvania capital stock tax in the amount of $1,134 (first $160,000 in valuation is deductible, leaving 1.89 mills tax on $600,000). In addition, each LLC member will pay tax on his or her individual state tax return on his or her portion of the company’s net income at the rate of 3.07%.
Partnerships. Income from partnerships is distributed to the individual partners, who then pay tax on the amount distributed to them on both their federal and state tax returns.
Example: For the 2012 tax year, your partnership had net income of $500,000. Each partner will pay tax on his or her individual state tax return on his or her portion of the company’s net income at the rate of 3.07%.
Sole Proprietorships. Income from your business will be distributed to you as the sole proprietor, and you will pay tax to the state on that income.
Example: For the latest tax year, your sole proprietorship had net income of $200,000. The $200,000 in net income is distributed to you personally, and you pay tax on that income on your individual state tax return at the rate of 3.07%.
Note on Multistate Businesses and “Nexus”
Our primary focus here is on businesses operating solely in Pennsylvania. However, if you’re doing business in several states, you should be aware that 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 Pennsylvania, it may be subject to Pennsylvania 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.
For further guidance on Pennsylvania’s corporate net income tax, and capital stock and foreign franchise taxes, check the Department of Revenue 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).