Who taxes what you earn?
Part 1 of an October series on who gets to tax you. Start with the opener: Your company does business where you do.
The federal government taxes all of it. The states split it up. Your home state claims everything, the states where you earn it claim their share, and a credit keeps you from paying twice on the same dollar. Mostly.
"What you earn" covers wages, business profit, and investment income. It also covers the taxes measured by those: income tax, payroll taxes, and in some states, franchise or gross receipts taxes on the business itself.
Your home state taxes everything
Your state of residence taxes all of your income, wherever it's earned. Which state that is, and how a second state can claim you as a resident anyway, gets its own post on Thursday, October 8.
Nine states don't tax wages: Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, and Wyoming. Living in one of them changes the math. Working in one of them while you live somewhere else doesn't.
Other states tax what's earned there
A state where you don't live can still tax income that comes from inside its borders:
wages for work you do while you're there
business income from operations there
rent from property there
gain when you sell real estate there
Your home state then gives you a credit for the tax the other state charged on that same income, usually capped at what your home state would have charged. So in general you pay the higher of the two rates, not both.
The catch is that the credit covers income taxes. A tax measured some other way, like gross receipts, capital, or a flat minimum, usually doesn't qualify. That's how the Washington LLC with an Idaho owner in the opener ends up with two taxes instead of one.
When your business owes a state
A business owes income tax in a state where it has nexus, meaning enough connection for the state to reach it. The common triggers:
an office, store, or warehouse
employees, including a single remote employee working from home
property or inventory, including inventory a marketplace stores for you
in a growing number of states, sales into the state above a dollar threshold, even with no presence at all
If your LLC is taxed as a partnership or is disregarded, the company usually doesn't pay the income tax itself. The income passes through to you, and you file a nonresident return in each state where the business earns it. Some states require the company to withhold or file a combined return on behalf of owners who live elsewhere.
The federal safe harbor, and how narrow it is
A 1959 federal law, Public Law 86-272, bars a state from taxing a company's net income if the company's only activity there is soliciting orders for physical goods that are approved and shipped from outside the state. People cite it as if it covers everyone. It doesn't.
It covers goods, not services. Consultants, agencies, software companies, and professional firms get no protection from it at all.
It covers income taxes only. It doesn't touch sales tax, franchise taxes, gross receipts taxes, or flat minimum taxes.
It's shrinking online. Multistate Tax Commission guidance treats a lot of website interaction, like post-sale chat support and certain cookies, as activity beyond soliciting orders, and several states have adopted that view.
Payroll follows the person
Withholding generally goes to the state where the employee does the work, not the state where the company is. One employee working from home in a new state usually means registering there for withholding and unemployment insurance. That same employee is often what gives the state nexus to tax the company's income, too.
A handful of states, New York the best known, go further and tax some remote employees' wages as if the work happened in-state, when working remotely is for the employee's convenience rather than the employer's need.
If you pay yourself through payroll, the structure matters too. Distributions, guaranteed payments, and salary covers the differences, and what "reasonable compensation" actually means for an S-corp owner covers the S-corp version.
Taxes on the business itself
Some states tax the business whether or not it made money. California charges LLCs an $800 annual tax. Washington has its B&O tax on gross receipts. Texas's franchise tax and Ohio's commercial activity tax apply once revenue passes their thresholds.
These belong under "what you earn" because they're measured by what the business brings in. They're also the ones the federal safe harbor doesn't reach and your home state usually won't credit.
What to do
For yourself: know which state is home, and keep track of where you actually work. For the business: list every state where you have people, property, or real sales volume, and check each one for income tax nexus, withholding, and entity-level taxes.
Keep reading: Distributions, guaranteed payments, and salary: what's the difference?; What "reasonable compensation" actually means for an S-corp owner; and What does an S-corp election actually commit you to?
Next in the series, Thursday, October 8: You split your time between two states. Which one taxes you?
This is general information, not legal advice for your situation. If you want an answer for your business, book a consultation.
