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; more particularly, 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.
Rhode Island has a business corporation tax and a franchise tax. In addition, if income from your business passes through to you personally, that income will be subject to taxation on your personal Rhode Island tax return.
Under Rhode Island’s business corporation tax, corporation income is taxed at a flat rate of 9.0%. While this makes it one of the highest corporate tax rates in the country, the rate potentially may be reduced to as low as 3% for qualifying companies that create new jobs. Also, there is a minimum business corporation tax of $500. Returns and payments are due on the 15th day of third month following the end of the corporation’s tax year. For purposes of comparison, note that Rhode Island taxes personal income at marginal rates ranging from 3.75% to 5.99%.
Rhode Island’s franchise tax is essentially a tax on net worth. The tax is $2.50 per $10,000 in authorized capital stock; for franchise tax purposes, stock with no par value is valued at $100 per share. There is a minimum franchise tax of $500.
Traditional (C-type) corporations pay the higher of either the business corporation tax or the franchise tax (with a minimum tax in all instances of $500). S corporations are subject only to the franchise tax.
Note: While not subject to either of the foregoing taxes, LLCs and limited liability partnerships (LLPs), though not general partnerships, are subject to an annual fee in an amount equal to the minimum corporate tax, i.e., $500.
Let’s briefly look at additional details for five of the most common forms of Rhode Island business: corporations (i.e., C corporations), S corporations, LLCs, partnerships, and sole proprietorships.
Corporations. Rhode Island corporations are subject to the greater of Rhode Island’s business corporation tax or franchise tax.
Example: For the 2012 tax year, your Rhode Island corporation had taxable net income of $500,000, and will owe more tax under the business corporation tax than under the franchise tax. Other things being equal, the corporation will owe Rhode Island business corporation tax in the amount of $45,000 (9.0% of $500,000).
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.) Rhode Island recognizes the federal S election, and Rhode Island S corporations are not required to pay corporate income tax to the state; however, Rhode Island S corporations are required to pay the state’s franchise 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 $200,000 and had $100,000 in authorized capital stock. The corporation will owe the minimum franchise tax of $500. In addition, each of the shareholders will pay tax on his or her individual state tax return on his or her portion of the corporation’s net income; each shareholder’s rate will vary depending on his or her overall taxable income for the year.
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 Rhode Island. However, Rhode Island LLCs are required to pay an annual fee equal to the minimum corporate tax of $500. In addition, an individual LLC member will owe tax on his or her share of the company’s income.
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 to Rhode Island’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 $200,000. The LLC will owe the annual fee of $500. 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; each member’s rate will vary depending on his or her overall taxable income for the year.
Partnerships. Income from general 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. (LLPs are required to pay an annual fee equal to the minimum corporate tax of $500.)
Example: For the 2012 tax year, your general partnership had net income of $200,000. Each partner will pay tax on his or her individual state tax return on his or her portion of the company’s net income; each partner’s rate will vary depending on his or her overall taxable income for the year.
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; your rate will vary depending on your overall taxable income for the year.
Note on Multistate Businesses and “Nexus”
Our primary focus here is on businesses operating solely in Rhode Island. 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 Rhode Island, it may be subject to Rhode Island 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 Rhode Island’s business corporation tax and franchise tax, check the Division of Taxation 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).