How do state and local corporate income taxes work?
Forty-four states and the District of Columbia levy corporate income taxes. Ohio and Texas tax corporate gross receipts rather than income. Nevada, South Dakota, Washington, and Wyoming had no corporate income tax or gross receipts tax in 2016.
How Much Revenue Do State and Local Governments Raise from Corporate Income Taxes?
State and local governments raise a relatively small share of revenue from corporate income taxes (table 1). States collected just $45 billion—4 percent of state own-source general revenue—from corporate income taxes in 2013 (own-source revenue excludes intergovernmental transfers). Local governments, including DC, collected only $8 billion—less than 1 percent of local government own-source general revenue. Only seven states allowed localities to levy a corporate income tax. New York City was responsible for 84 percent of corporate income tax revenue collected by local governments; DC accounted for another 6 percent.
New Hampshire collected 13 percent of state own-source general revenue from corporate income taxes in 2013, the highest share of revenue of any state. Corporate income taxes were 5 percent or more of state revenue in eight other states; Alaska, Delaware, Illinois, Massachusetts, Minnesota, New Jersey, New York, and Tennessee—also in DC. Among the 44 states with corporate income taxes three (Hawaii, Louisiana, and South Dakota) collected less than 2 percent of revenue from the tax.
Corporate income tax revenue was 6 percent of local government own-source general revenue in New York, the only state among the seven that permit local government to levy a corporate income tax in which revenue from the tax was more than 2 percent of revenue. DC’s corporate income tax provided nearly 6 percent of its own-source general revenue in 2013.
What Income Is Taxed?
Most states use the federal definition of corporate income as a starting point. However, states deviate from federal rules in some instances. For example, when the federal government enacted “bonus depreciation” in 2008, which allowed businesses to deduct a larger portion of capital investment in the year the investment is first made, many states did not enact conforming rules.
While states benefit from federal tax administration and enforcement by following the federal definition of corporate income, they must take additional steps in the case of multistate corporations to determine what portion of that income is taxable in their states.
States must first establish whether a company has “nexus” in the state, that is, enough physical or economic presence to owe income tax. Next, they must determine the taxable income generated by activities in the state. For example, multistate companies often have subsidiaries in no-tax or low-tax states that hold intangible assets such as patents and trademarks. The rent or royalty payments to those wholly owned subsidiaries may or may not be considered income of the parent company operating in another state. Finally, states must determine how much of a corporation’s taxable income is properly attributed to that state.
Until recently, most states used a three-factor formula based on the Uniform Division of Income for Tax Purposes Act to determine the portion of corporate income taxable in the state. That formula gave equal weight to the shares of a corporation’s payroll, property, and sales in the state. In the last 20 years, however, states have moved toward formulas that either weight more heavily or rely exclusively on sales within the state to apportion income. By using the portion of a corporation’s sales rather than employment or property to determine tax liability, states hope to encourage companies to relocate or to expand their operations within these states.
How Much Do Corporate Income Tax Rates Differ across States?
In 2016, top corporate income tax rates ranged from 4 percent (in Kansas and North Carolina) to 12.0 percent (in Iowa) (figure 1). Five states (Alaska, Iowa, Minnesota, New Jersey, and Pennsylvania) and DC had top corporate income tax rates at or above 9.0 percent. Nine others (Arizona, Colorado, Florida, Kansas, Mississippi, North Carolina, North Dakota, South Carolina, and Utah) had top rates below 6.0 percent.
Nevada, South Dakota, Washington, and Wyoming levied no corporate income taxes in 2015. Ohio and Texas taxed corporate gross receipts rather than income.
Federation of Tax Administrators. State Income Taxes. “Range of State Corporate Income Tax Rates (Tax rates for tax year 2015 -- as of January 1, 2015).”
US Census Bureau. State & Local Government Finance.
Tax Policy Center. “State and Local Finance Data Query System.” Urban Institute and Brookings Institution, Washington, D.C.
Brunori, David. 2005. State Tax Policy: A Political Perspective, 2nd ed. Washington, DC: Urban Institute Press.
———. 2007. Local Tax Policy: A Federalist Perspective, 2nd ed. Washington, DC: Urban Institute Press.
Federation of Tax Administrators. “State Apportionment of Corporate Income.”
Gordon, Tracy. 2010. “Take the State Corporate Income Tax… Please!” TaxVox (blog). May 14.