How to Report Taxable Income from Multiple States

If a business has a physical nexus (sufficient physical presence – which can be people and/or property) within a state, that state then has the right to tax the business. Public Law 86-272 prevents states from taxing businesses simply because customers buy a business’ products within their borders. However, this law only applies to tangible personal property and not to sales of services or intangible property (i.e. trademarks). Thus, in some states, a business that receives income for intangible assets will be considered to have established an economic nexus within the state. It is important to understand how to report taxable income from multiple states so you don’t end up paying more than you have to in the long run.

What is Taxable Income?

Taxable income is usually determined by the federal taxable income before special deductions (depending on the state’s definition), which includes net operating loss deductions and the dividends-received deduction. This amount is then adjusted by multiple factors:

Interest from Federal Bonds

You can subtract interest received from federal bonds since this is not subject to state taxes.

Municipal Bonds

You add the interest from municipal bonds that are not subjected to federal taxation but are subject to state taxation.

State Income Taxes

You add the federal deduction for state income taxes, as this is not allowed to be deducted from state taxes.

Differences in Depreciation Methods

You must account for differences in depreciation methods between state and federal government requirements.

How Different Companies Report Taxable Income

Partnerships

The partners end up paying the tax, hence a partnership is handled the same as individuals would be.

Limited Liability Company

It is the company’s choice to decide whether it would like to be treated as a corporation or a partnership in the eyes of the federal government. However, while there are some states that follow the federal election that the company chooses, other states disregard the decision and tax LLC’s as a partnership.

S Corporation

Shareholders must file a tax return in every state where their company has a nexus. On top of that, some states go the extra mile and charge a state corporate income tax.

Reporting Taxable Income in Multiple States

A company that has all of their locations in one state has fairly straight forward tax procedures for its income taxes. However, what happens in the situation where a company has locations outside state lines? In comes the rivalry between reporting and separate accounting.

Combined Reporting

Combined reporting requires a company with locations in multiple states to sum up the profits of all its subsidiaries no matter the location, and put the amount into one report. This approach is much less friendly to those seeking to optimize tax strategies.

Separate Accounting

This type of accounting allows a company to report the profits of each of its subsidiaries into multiple reports, making it a viable option for companies that report from different states. As a result, within this method it is much easier to limit tax expenditures, such as the use of a passive investment company.

Corporate Income Tax Apportionment

Within each state, there are rules for dividing a corporation’s profits when said corporation has nexus within that state. These rules determine the amount of profits that are considered in-state and out-of-state. After this is done, the state can tax the in-state portion.

As a business owner, you are responsible for understanding how to report taxable income if you operate across state lines. The good news is: you don’t have to figure it out by yourself. Give us a call and we will get started for free and walk you through the entire process.

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  • July 13, 2022

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