How to Navigate State and Local Taxes for Your Small Business

Running a small business comes with many responsibilities—and managing taxes is one of the most critical. While most entrepreneurs focus on federal taxes, overlooking state and local tax obligations can result in compliance issues, penalties, and unexpected expenses. Every state and locality has its own rules, which can make navigating them feel overwhelming.

This guide will help you understand how state and local taxes work, what you need to watch out for, and how to stay compliant—so you can keep your business running smoothly and avoid costly surprises.

Understanding the Layers of Taxation

Small business taxes are not just a federal concern. In the U.S., businesses often have to deal with three levels of taxation:

Federal Taxes – Filed with the IRS.
State Taxes – Based on the state in which you operate or earn income.
Local Taxes – Imposed by cities, counties, or municipalities.

Each level may impose taxes on income, sales, payroll, and property, among others. Understanding where you have obligations is key to full compliance.

State Income Taxes: Know Where You Owe

Not All States Tax Income

Some states—such as Texas, Florida, and Nevada—do not impose individual or corporate income tax. However, most states do require small businesses to pay income tax based on their net profits. The tax rates and rules can vary widely:

Flat-rate states: Charge a consistent percentage (e.g., Colorado at 4.4%).
Graduated-rate states: Increase tax rates as income rises (e.g., California, New York).
Entity-specific rules: LLCs, S Corps, and C Corps may be taxed differently depending on the state.

Filing State Returns

If your business operates in more than one state or earns income across state lines, you may need to file in multiple states. This is known as multi-state taxation and usually depends on whether you have nexus in that state (more on that below).

Understanding Nexus: When Do You Owe Taxes in Another State?

Nexus is a legal term that refers to a sufficient connection between your business and a state, triggering tax obligations. Nexus can be established through:

A physical location (office, warehouse, store)
Employees or contractors working in the state
Shipping products to customers regularly
Reaching a threshold of sales or transactions (economic nexus)

If you have nexus in a state, you may be required to:

Collect and remit sales tax
File state income tax returns
Register your business with the state

Knowing where you have nexus is crucial to avoid fines and back taxes.

Sales Tax: More Complex Than Ever

Collecting Sales Tax on Products

Most states require businesses to collect sales tax on the sale of tangible goods. However, the taxability of goods can vary. For example:

Some states exempt groceries or clothing.
Others tax digital products like eBooks or software downloads.

Sales tax rates also vary by state, county, and city, meaning the final rate charged to your customer could depend on their delivery location.

Sales Tax on Services

Services may or may not be taxable, depending on the state and the type of service. For example:

Personal services (haircuts, cleaning) are often taxed.
Professional services (legal, consulting) are usually exempt—but not always.
Online or digital services (streaming, cloud computing) may be taxed in some states.

Registering for Sales Tax

If your business must collect sales tax, you’ll need to:

Register for a sales tax permit in each applicable state.
Charge the correct tax rate on each sale.
File regular sales tax returns (monthly, quarterly, or annually).
Remit the collected tax to the proper authority.

Failing to do so can result in penalties, interest, and audits.

Local Business Taxes: Don’t Overlook These Hidden Costs

In addition to state taxes, many cities and counties impose their own taxes. These can include:

Local income taxes (e.g., New York City, San Francisco)
Business license taxes or fees
Gross receipts taxes (taxes on total revenue, not profit)
Occupational taxes or permits for specific industries

Check with your local city or county government to identify your obligations. These requirements are often overlooked but can be just as important as state and federal taxes.

Payroll Taxes at the State and Local Level

If you have employees, you’re required to handle payroll taxes—not just federally, but at the state and sometimes local levels.

Common State Payroll Taxes Include:

State income tax withholding
Unemployment insurance (SUTA)
Disability insurance (in some states like CA, NY, NJ)

Local Payroll Taxes

Certain localities, such as Philadelphia and parts of Ohio, also impose employer-paid payroll taxes. Make sure your payroll system accounts for all applicable jurisdictions.

State Franchise Taxes and Other Annual Fees

Some states charge an annual franchise tax or minimum business tax, regardless of profitability. These are often flat fees or calculated based on net worth, capital stock, or gross receipts. For example:

Delaware charges an annual franchise tax on corporations.
California imposes an $800 minimum tax on LLCs and corporations.

Don’t confuse these with income taxes—they are separate and still due even if your business loses money.

Tips to Stay Compliant with State and Local Tax Laws

Register Your Business Properly
Ensure you're registered with the Secretary of State and tax authorities in each state you operate.
Use Sales Tax Automation Tools
Software like Avalara, TaxJar, or QuickBooks can help automate sales tax collection and filing.
Track Nexus Changes
Economic nexus thresholds can change, especially as your business grows or expands online. Monitor your activities in each state.
Hire a Multi-State Tax Expert
State and local taxes are complex and ever-changing. Work with a CPA who specializes in multi-state compliance.
File On Time
Each jurisdiction has its own deadlines for sales tax, income tax, and license renewals. Missing a deadline can result in hefty penalties.
Maintain Good Records
Keep detailed records of income, expenses, payroll, sales tax collections, and filings for at least 7 years.

Conclusion: Stay Proactive to Avoid State and Local Tax Pitfalls

State and local taxes can be a minefield for small business owners—but with a little preparation and the right tools, you can navigate them successfully. The key is to stay informed, remain organized, and seek professional guidance when necessary.

Ignoring state and local tax obligations can lead to penalties, audits, and even suspension of your business license. But taking control now means fewer surprises later and more energy to focus on what really matters—growing your business.

Need help with a specific state’s tax rules or planning a business expansion into a new location? I can help tailor this information to your unique situation—just let me know!

How to Navigate State and Local Taxes for Your Small Business