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.
11. New Jersey:
NJ has an S-Corp Minimum Tax (MT) based on NJ gross receipts (GR), which includes net trading gains. It is $375 for less than $100,000 GR, $562.50 for less than $250,000 GR, $750 for less than $500,000 GR, $1,125 for less than $1M GR, and $1,500 if $1M GR or more. See S Corporation – MINIMUM TAX on Corporation Business Tax Overview.
NJ has a Partnership Filing Fee: “For New Jersey Gross Income Tax purposes, every partnership or limited liability company (LLC) that has income from sources in the State of New Jersey, or has a New Jersey resident partner, must file the New Jersey Partnership return, Form NJ-1065. The $150/partner fee is not to exceed $250,000 for each partnership with more than two partners. Assessed on partnerships with more than two partners AND having income or loss derived from New Jersey sources…,” per Partnership Filing Requirements.
NJ has a progressive individual income tax system, and the top rate is 8.97% on income over $500,000.
NJ individual income tax rates are lower than New York State/City rates, but many traders pay higher taxes in NJ because it does not allow deductions for most losses*. That includes business losses, caused by trading business expenses, net capital losses and net Section 475 ordinary trading losses. NJ only allows certain itemized deductions. NJ’s restrictions on deductions translate to higher effective tax rates. Many traders have net losses in some years, and they do not find tax relief in NJ.
*NJ Notice: “ALTERNATIVE BUSINESS CALCULATION DEDUCTION FOR CERTAIN BUSINESS ENTITIES CONSOLIDATION AND CARRYFORWARD. Effective for tax years beginning on or after January 1, 2012, (NJ) establishes an alternative business calculation deduction under the New Jersey Gross Income Tax Act with the intent of giving income tax relief to taxpayers with business losses. The new legislation provides a deduction which uses a calculation that consolidates business income and/or loss and allows taxpayers to carry forward unutilized losses.” (See examples in the notice.)
NJ has an estate tax rate up to 16% and an exemption of $675,000, which is the lowest exemption in the country.
NJ has an inheritance tax rate up to 16%.
With high individual tax rates, disallowance of most losses*, high minimum tax on S-Corps, and the lowest estate exemption in the country, NJ is one of the worst tax states for traders.
WA has a Business & Occupation Tax (B&O) assessed on gross receipts from business activities. See Business & Occupation tax. Tax rates vary by classification, with the highest rate 0.15% applying to a service business.
WA exempts a trading company from B&O tax, providing it does not have other types of income like management fees or profit allocation (carried interest) in a hedge fund. (Learn more on the WA site: Income derived from investments.)
WA does not have an individual income tax system.
WA has the highest estate tax rate (20%) in the country, and the estate exemption is 2.054M.
WA is a good tax state for traders to live in, but not a good place to pass away, if you exceed the estate exemption.
MA subjects S-Corps to a 0.26% Corporate Excise Tax (CET). It’s applied to MA tangible property or taxable net worth (TNW), which includes trading equity capital and undistributed trading income. The minimum CET is $456, which translates to $175,384 TNW. On $500,000 TNW, CET is $1,300. See MA Corporate Excise Tax.
S-Corps with high gross receipts, which includes net trading gains, may also be subject to an income tax measure of CET. “S-Corps with total receipts of $6 million or more are liable for the income measure of the corporate excise at the following rates: 1.83% on net income subject to tax if total receipts are $6 million or more, but less than $9 million; or 2.75% on net income subject to tax if total receipts are $9 million or more,” per MA tax site.
Most trading companies have trading gains under $6M, so they do not owe the income portion of CET. If you expect trading gains significantly over $6M, consider a dual entity structure: A trading general partnership, which is free of all CET, and an S-Corp management company paying the $456 minimum CET.
MA requires an LLC to file an annual report with a $500 fee. MA does not require an annual report from a general partnership.
MA has an individual income tax regime, with two flat tax rates for 2016. Per MA Personal Income Tax:
- 5.1% tax rate on earned income (salaries, wages, tips, commissions) and unearned income (interest, dividends, and certain capital gains);
- 5.1% tax rate on long-term capital gains (except collectibles);
- 12% tax rate on short-term capital gains, and Section 475 MTM ordinary income from trading gains earned by business traders who made a timely Section 475 election.
MA has an estate tax rate up to 16%. MA has an estate exemption of $1M, which is low among the fifteen states that have an estate tax regime.
Most MA residents pay individual income taxes at the 5.1% rate, which is competitive. But, traders owe the higher 12% rate on short-term capital gains and Section 475 ordinary income, which makes MA a bad tax state for traders.
Attend our Webinar or watch the recording afterward: Trader Tax Battle Of The States.