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 most often are flat regardless of the amount of income, generally range from roughly 4% to 10%. 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, six states – Nevada, Ohio, South Dakota, Texas, Washington, and Wyoming – do not have a corporate income tax. However, four of those states – Nevada, Ohio, Texas, and Washington – do have some form of gross receipts tax on corporations. Moreover, five of those states – Nevada, South Dakota, Texas, Washington, and Wyoming – as well as Alaska and Florida currently 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 justified as a tax simply for the 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.
Note: As of Spring 2018, Iowa is overhauling its state tax system. As recently as June 1, 2018, the Iowa Department of Revenue stated in a press release that the new tax law will modify both corporate and individual rates, and various changes will be implemented on different dates. This article is based on the existing Iowa state rules prior to implementing the new law.
Iowa is like most states in that it has a corporate income tax, but unlike many states in that it does not have any franchise or privilege tax generally applicable to businesses. Thus, for the most part, unless your business is a traditional corporation (a C corporation), your business itself will not be subject to a state tax on income or net worth. However, if income from your business passes through to you personally, that income will be subject to taxation on your personal state tax return.
Iowa taxes corporation income using a series of marginal tax rates, or, in some instances, an alternative minimum tax. The more specific breakdown of tax rates is as follows:
The alternative minimum tax (AMT) applies if it would result in a greater amount due than under the foregoing rates. Iowa’s AMT on corporation income is based on the federal AMT rules, but with multiple adjustments, and is imposed at the rate of 7.2%. (By way of comparison, Iowa marginal tax rates on personal income range from .36% to 8.98%, as well as a 6.7% AMT.) State tax returns are due on the last day of the fourth month after the close of the tax year. For companies whose tax year corresponds with the calendar year, this means returns are due on April 30th.
Let’s briefly look at additional details for five of the most common forms of Iowa business: corporations (C corporations), S corporations, LLCs, partnerships, and sole proprietorships.
Corporations. Iowa corporations are subject to Iowa’s corporate income tax at marginal rates ranging from 6% to 12%, with subtractions, or to the state’s alternative minimum tax. (As noted, Iowa currently is reforming its tax laws.)
Example: For the latest tax year, your Iowa corporation had taxable income of $200,000. Other things being equal, putting aside upcoming tax reforms, and assuming the alternative minimum tax does not apply, the corporation will owe Iowa corporate income tax in the amount of $14,500 (first $25,000 taxed at 6% = $1,500; next $75,000 taxed at 8% = $6.000, minus $500 = $5,500; remaining $100,000 taxed at 10% = $10,000, minus $2,500 = $7,500).
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.) Iowa recognizes the federal S election, and Iowa S corporations are not required to pay corporate income tax to the state. However, an individual S corporation shareholder will owe tax on his or her share of the company’s income.
Example: For the latest tax year, your S corporation had net income of $200,000. Putting aside potential upcoming state tax reforms, the $200,000 in 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. 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 are not required to pay income tax to either the federal government or the State of Iowa. Instead, income from the business is distributed to the LLC members, and each individual member is subject to federal and state taxes on his or her share of the company’s income.
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 be subject to Iowa’s corporation income tax.
Example: For the latest tax year, your multi-member LLC, which has the default tax classification of partnership, had net income of $200,000. Putting aside potential upcoming state tax reforms, the $200,000 in net income will be divvied up between you and your fellow LLC members, and each member will pay tax on his or her own portion on his or her individual state tax return; each member’s rate will vary depending on his or her overall taxable income for the year.
Partnerships. Income from partnerships is distributed to the individual partners, and each individual partner is subject to federal and state taxes on his or her share of the partnership’s income.
Example: For the latest tax year, your partnership had net income of $200,000. The $200,000 in net income will be divvied up between you and your fellow partners, and each partner will pay tax on his or her own portion on his or her individual state tax return. 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; the 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 Iowa. 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 Iowa, it may be subject to Iowa 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.
Because Iowa appears to be changing its corporate and other tax laws, its particularly important to periodically 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 Frederick Daily (Nolo).
June 12, 2018