Trader Tax Battle Of The States: Midwest Vs. Southeast Top 10 States

July 14, 2016 | By: Robert A. Green, CPA

Click to read Green's blog post in Forbes.

Click to read Green’s blog post in Forbes.

Traders have unique tax issues on state and local income tax returns for business entities and individuals. Moreover, state and local tax regimes vary significantly. The preferred business entity for a trader is an S-Corp pass-through entity, which is free of entity-level federal taxation. Some states and cities subject S-Corps to taxation. (Read our recent blog post: A Few States Tax S-Corps: Traders Can Reduce It.)

In my five-part series “Trader Tax Battle Of The States,” I focus on state and local tax systems for S-Corps, LLCs, and partnerships. I mention basic information about individual income tax, estate and inheritance tax regimes. The numbers listed below are the states ranking by population.

5. Illinois:

IL has a 1.5% Replacement Tax (RT) on partnerships, trusts, and S corps. There is an exemption for an “investment partnership” per Illinois Income Tax Act (IITA) Section 1501(a)(11.5). An LLC filing a partnership return qualifies for this exemption, but an S-Corp does not.

The 1.5% RT rate is meaningful, so it is important for traders to reduce it. There are two ways: Trade a smaller amount of funds in an S-Corp, so you do not owe significant RT.

Alternatively, if you have a larger amount of capital and expect high income, use a dual entity structure: A trading general partnership, which is exempt from RT, and an S-Corp management company, with reduced RT. The partnership pays the S-Corp a monthly administration fee and profit allocation defined in the partnership agreement. The S-Corp lowers it’s net income and RT, by deducting officer compensation and employee benefit plans, including health insurance premiums and retirement plan contributions. Most trading income remains in the general partnership, free of RT.

IL has an individual income tax system with a 3.7% flat rate. (Update July 6, 2017: IL raised the flat rate to 4.95%)

IL has an estate tax rate up to 16% and an exemption of 4M.

IL reminds me of New York City, with lots of traders working for banks and trading firms nearby commodity and futures exchanges. While most people do not think of IL as a low tax state, its 3.7% flat tax rate on individual income is competitive, and traders can reduce RT on S-Corps.

6. Pennsylvania:

The PA legislature repealed the Capital Stock Tax on LLCs and S-Corps and completed the phase-out by December 31, 2015.

PA has an individual income tax system with a 3.07% flat rate.

PA has an inheritance tax rate up to 15%, but no estate tax.

7. Ohio:

OH has a 0.26% Commercial Activity Tax (CAT) based on taxable gross receipts (TGR). TGR do not include interest (other than from installment sales), dividends, and capital gains. See the CAT table at Important Changes to the Commercial Activity Tax in 2014.

A trading company should owe the minimum CAT of $150 since TGR excludes trading gains.

OH has a progressive individual income tax system, and the top rate is 4.997% on income over $208,500.

OH has no estate or inheritance tax.

8. Georgia:

GA has a net worth (NW) tax on S-Corps. The tax table has many brackets, and here are some examples: $100 for NW less than $100,000, $250 for NW less than $500,000, and $500 for NW less than $1M. See Net Worth Tax Table (pages 8-10) in GA’s 2015 S-Corp Income Tax instructions.

NW includes equity and undistributed income, which means it includes trading capital and undistributed trading gains.

S-Corps and partnerships do not pay an income tax, except they must withhold personal income tax on amounts paid to nonresident shareholders and partners.

GA has a progressive individual income tax system, and the top rate is 6% on income over $10,000 (married filing joint).

GA does not have an estate or inheritance tax.

9. Michigan:

MI does not subject S-Corps and partnerships to Corporate Income Tax (CIT) unless it is a financial institution or insurance company.

MI has an individual income tax system with a 4.25% flat rate.

MI does not have an estate or inheritance tax.

10. North Carolina:

NC has a 0.15% Franchise Tax (FT) on S-Corps based on net worth (NW) or appraised value of NC tangible property. The minimum FT is $35. For example, FT is $150 on $100,000 NW. 2015 North Carolina S Corporation Tax Return Instructions on page 3.

Trading equity capital is part of NW, so if you have significant trading capital, consider a dual-entity trading structure: A trading partnership, which is free of FT, and an S-Corp management company with reduced FT, after paying officer compensation and employee benefit plans.

NC has an individual income tax system with a 5.75% flat rate.

NC does not have an estate or inheritance tax.

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