Before you start or move your business, it can be beneficial to look at the tax-friendliness of states you’re considering operating in. For example, if you want to relocate to a state that has consistently warm weather, you might consider Florida, which is also one of the most tax-friendly states for businesses.
This article looks at a tax-friendly ranking of states, discusses factors that are included in the ranking, and presents some trends in state tax laws.
- The most tax-friendly U.S. states are Wyoming, South Dakota, Alaska, Florida, and Montana.
- The least tax-friendly states are Minnesota, Connecticut, New York, California, and New Jersey.
- State tax friendliness is measured by comparing several types of taxes, including corporate and individual tax rates, sales and excise taxes, property taxes, and unemployment insurance taxes.
- In 2021, 21 states made state tax changes resulting in lower taxes for individuals and businesses.
What Makes a State Tax-Friendly for Businesses?
The Tax Foundation, a nonpartisan tax research group based in Washington, D.C., released a State Business Tax Climate Index study in December 2021. It ranks the best and worst states for business taxes to help policymakers and business leaders compare their state's tax systems against others, and it reveals the states with the best-structured tax systems.
This study factored in the most common taxes affecting businesses, using a weighting factor to come up with a percentage of the total for each type:
- 31.2% – Individual income tax
- 23.7% – Sales tax
- 20.9% – Corporate Tax
- 14.4% – Property Tax
- 9.8% – Unemployment insurance Tax
Individual Income Taxes
Sole proprietors, limited liability company (LLC) owners, partners in partnerships, and S corporation owners are affected by individual income tax rates and changes because they pay business income tax as part of their individual income tax returns. This process is called pass-through business taxation.
Small business owners considering different states should pay close attention to the individual income tax structure in each state. States with higher marginal tax rates (the amount of additional tax paid for each additional dollar of income) are less tax-friendly than those with lower marginal rates. Get help from a tax professional in reviewing these tax situations.
Corporate Income Taxes
Corporations pay income tax based on corporate tax rates. All states except Nevada, Ohio, Texas, and Washington levy a corporate tax income tax, with rates ranging from 2.5% in North Carolina to 11.5% in New Jersey. Thirty states and the District of Columbia have one income tax rate for all corporations.
Some states require corporations to pay a gross receipts tax instead of, or in addition to, corporate income tax. This tax is applied to a company’s gross receipts with no deductions for expenses. Washington, Tennessee, and Texas don’t have taxes on wage income but they do have a gross receipts tax for S corporations, and Washington and Texas apply this tax to LLCs.
Sales Taxes and Excise Taxes
Sales tax rates are an important component of business friendliness, because low or no sales taxes encourage consumer purchases, especially in comparison with adjoining states. For example, Delaware has no sales tax so it attracts buyers from all over the Mid-Atlantic region.
States impose excise taxes on specific goods or activities, like cigarettes, alcoholic beverages, soda, gasoline, amusement activities. They are a relatively small part of state and local tax collections.
Sales and excise taxes sometimes offset each other. Alaska, Montana, New Hampshire, Oregon, and Washington have no state sales taxes but they have excise taxes, and Alaska allows local option sales taxes.
States impose property taxes on privately owned property of businesses and individuals, including land, cars, and business inventories. The tax system in each state is administered by localities, which calculate the rate by a percentage of the tax value of the property. In addition to real property (land and buildings), many localities and states levy taxes on personal property and equipment.
Property taxes have been found to have a negative impact on business startups because they must be paid even if the business doesn’t make a profit. In the Tax Foundation Index, Indiana has the lowest property tax rate, and Connecticut has the highest.
Unemployment Insurance Taxes
Unemployment insurance (UI) (a payroll tax paid by businesses) is a joint state-federal program to provide benefits for recently unemployed workers. Every state has a UI tax, with a complex system of different rates for different industries and bases.
Unemployment insurance taxes are a minor component of the tax-friendliness index because the rates are similar around the U.S. But if a state changes its unemployment tax rate, it could significantly affect its ranking. Pennsylvania, for example, made improvements to its UI taxes in 2021, cutting the rate and repealing a surtax to be more competitive, increasing its rank from 32nd to 29th overall.
Other Taxes Considered in the Listing
Some other less common taxes imposed by states affect their ranking in the Index.
Six states have inheritance taxes and these taxes are included in the Index because they cause economic distortion. For instance, Maryland has both an estate tax and an inheritance tax, while New Jersey repealed its estate tax.
Connecticut, meanwhile, is the only state that has a standalone gift tax. This is designed to prevent attempts to avoid estate taxes but can have a negative effect on small business owners who operate as sole proprietorships, S corporations, or LLCs.
The Most Tax-Friendly States for Business
- Wyoming has no individual income tax and it’s one of only two states that doesn’t levy a corporate income tax or a gross receipts tax.
- South Dakota has no individual income tax, and this is the other state without a corporate income tax or gross receipts tax.
- Alaska levies no individual income tax or state-level sales tax.
- Florida has no individual income tax and it has a low unemployment insurance tax.
- Montana’s constitution limits its sales tax to 4%.
- New Hampshire has no state-level sales tax.
- Nevada has no corporate, franchise, or individual income tax.
- Tennessee eliminated its tax on interest and dividend income in 2021 and made other changes favorable to pass-through businesses. The state jumped from 17th to 8th place in the rankings.
- Indiana levies all the major types of taxes, but it has low rates on broad bases.
- Utah scores high in part because it’s one of seven states that has a single lower-income tax rate and its corporate tax rate is just 4.95%.
Oregon slipped out of the top 10 most tax-friendly states from the 2021 index, replaced by Tennessee in the 8th spot, and Utah and Indiana switched places.
Most of these top 10 states don’t have a major tax, although property taxes and unemployment insurance taxes are levied in every state. However, a state can still rank in the top 10 even while levying all the major taxes.
The Worst States for Business Taxes
41. Hawaii has the second-highest individual income tax rate at 11.0%.
42. Louisiana has a very high sales tax.
43. Vermont has very high property taxes.
44. Arkansas is known for its high sales taxes.
45. Minnesota has high individual and corporate tax rates. The state’s top corporate tax rate is 9.8% as of 2021.
46. Maryland has a high individual income tax rate, and it’s the only state with both an inheritance tax and an estate tax.
47. Connecticut has some of the highest property taxes in the nation.
48. California has the second-highest individual top income tax rate in the nation—13.3% as of 2021—and the second-highest corporate tax rate at 8.84% for corporations other than banks and financials (which have a.10.84% rate)
49. New York has the highest top individual income tax rate in the nation and it has pretty prohibitive property tax rates as well.
50. New Jersey has the third-highest individual income tax rate in the U.S. and its corporate, sales, and property taxes are very high as well. The state’s top corporate tax rate is 11.5% as of 2021.
Changes and Trends in State Taxes
According to the Tax Foundation, the 2021 state legislative sessions seemed to follow a theme of income tax relief. States had revenue increases, some of which came from transfers from federal pandemic relief measures, including the CARES Act and the American Rescue Plan Act. As a result, states with revenue growth saw an opportunity for tax relief and the possibility of increasing their competitive position with adjoining states.
Many states made changes to their income taxes in 2021, with 11 states lowering their income tax rates, 10 cutting individual income tax rates, and five reducing corporate income tax rates. Five states – Arizona, Idaho, Iowa, Montana, and Ohio—made changes to their income tax brackets (the range of incomes at a certain rate), reducing the number of brackets to create a more neutral structure. Arizona, Idaho, Louisiana, Ohio, and Oklahoma reduced their marginal income tax rates.
On the other hand, some states made less favorable changes to tax laws. Illinois, for example, temporarily changed its treatment of net operating losses to be less favorable to businesses. And some states opted to tax Paycheck Protection Program (PPP) loans despite the fact that Congress exempted them from federal income tax.
Frequently Asked Questions (FAQs)
What are the best states for sole proprietors worried about taxes?
Sole proprietors pay their business taxes as part of their personal income tax returns, so they must pay attention to tax rates on individuals.
One major factor in looking for the best state for a sole proprietor business is whether there is a state income tax and how high it is. Eight states have no tax on earned income, while at the other end of the tax spectrum are states with income tax rates as high as 13.3% (California), 10.9% (New York), and New Jersey (10.75%).
Which states have the best property tax rates for nonresidents?
Anyone who owns property, including land, cars, and business inventory, must pay property taxes to their locality based on the state tax rate and the value of the property. The tax rate is the same for all property owners in a state, including nonresidents, but nonresidents may not be eligible for special exemptions available to residents only.
The states with the lowest property tax rates are Hawaii, Alabama, Louisiana, and Wyoming. In comparison, New Jersey, Illinois, and New Hampshire had the highest property tax rates.