Personal Finance

Why you should think twice before moving your business to a low-tax state

Key Points
  • Under the new tax law, owners of LLCs may be eligible for a 20 percent deduction on qualified business income.
  • Saving on state and local taxes is now a focal point for entrepreneurs.
  • Shifting your small business to tax-friendly locales like Florida is easier said than done.
Gary Burchell | Getty Images

If you're looking to save big on taxes by packing up your small business and shipping it to a friendlier state, it may be time to hit the brakes.

The new federal tax law grants special breaks for owners of businesses — there's the 20 percent deduction on qualified business income and lower tax rates for C-corporations — and entrepreneurs are searching for additional ways to save on state and local levies as well.

That's especially valuable because on individual returns, filers can only deduct up to $10,000 in state and local taxes, which include income and property taxes.

"Companies are determining whether they can move their business to low tax jurisdictions," said Lance D. Christensen, partner at accounting firm Margolin Winer & Evens.

"It's a question that's one of many asked as a result of this sweeping tax legislation," he said.

Leaving New York for Florida sounds like a no-brainer, yet tax professionals warn that entrepreneurs should proceed with caution. It'll take more than just moving your headquarters to ramp up your savings.

Here's what you should know before relocating.

Location, location, location

The issue of "tax nexus" — where you conduct your business — matters when it comes to whether you can easily pack up and move.

Establishing a tax nexus is based on a number of factors, including where your employees are, where your property is located and whether you have inventory in a particular location.

Based on whether you have a nexus in a given state and the nature of your business, your company may be required to pay income and sales taxes there.

Click on the image below for more information on sales taxes across the country.

This is why it's easy for a one-person shop — say, an Uber driver — to pick up and move from New York to Florida, but it's not so simple for a business with multiple locations and a wide client base.

"If half of my property is in North Carolina and half in New York, I need to file returns in both states," Christensen said. "The taxes apportioned to those states will be based on shipments of property, where services are provided, and where the property is."

States themselves also use different methods to collect taxes from companies. Some assess levies based on where the work is performed, while others tax businesses based on where the customers are located.

Changing residency

Maybe you and your business can easily flee to a state with lower taxes.

In that case, you'll need to establish domicile — your true permanent home — in that new state in order to benefit from their friendlier taxes.

"We would recommend a driver's license change and updating your voter's registration, but it goes beyond that," said Christensen. "It's where your social clubs are, where you return when you go on vacation."

See below for a breakdown of state income taxes.

Work with your tax planner to make sure you get this right.

New York, which has a top marginal income tax rate of 8.82 percent, has been known to challenge individuals who claim to have left the Empire State for income-tax-free Florida.

Structure matters

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If it's difficult to uproot your business, talk to your accountant about whether it makes sense to change your company's structure from a pass-through entity to a C-corp.

Under the new tax law, pass-through entities — including S-corps, partnerships and limited liability companies — may qualify for a 20 percent deduction of qualified business income.

These small businesses get their name from the way income and profits "pass through" to the owner's individual tax return. Pass-throughs are subject to individual income tax rates, which run as high as 37 percent.

Business owners with C-corps can take aggressive deductions — and they're subject to a corporate tax rate of 21 percent.

"If you're paying taxes in many different states, you should consider the large state and local income tax deduction that you can get as a C-corp but not as a pass-through entity," said Mark Nash, a tax partner at PwC.

However, C-corps are subject to double taxation, meaning profits are taxed to the corporation and then levied a second time when shareholders get their dividends.

Your accountant may help you develop a strategy to soften the blow.

"You might be able to avoid the double tax if you reinvest in the growth of the business," Nash said.

More from Personal Finance
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How to navigate that 20 percent tax break for small businesses.