TAXES & LICENSES

State and Local Income Tax

In addition to paying federal income taxes, you may also be subject to paying state and local income taxes on the earnings from your business. Typically, state income taxes are imposed by the state or local government in the jurisdiction you live or are conducting business in. The good news is that the IRS allows you deduct these taxes when you prepare your federal tax return, which may be applicable for both business owners and employees, the only difference being where you claim the deduction.

PHOTOGRAPHER

Sarah Fang is a sole proprietor photographer from New York city who covers the Fashion world. Sarah physically does business in New York and Los Angeles each for six months out of the year. Even though Sarah lives in NYC, she will owe tax in both California and New York for the portion of her income earned while she was working in each state. The good news is when Sarah prepares her federal income tax return if she chooses to itemize her deductions she will be able to deduct the state income taxes she paid to New York and California on line 5a of her Schedule A.

PROFESSIONAL SERVICES

Matt is a Lawyer based out of Delaware who has organized his business as a single member LLC. In March, Delaware imposed a $300 franchise tax on Matt's business. When Matt prepares his Schedule C in April of the following year, he can deduct the franchise tax payment on line 23. Matt cannot however deduct the state income tax he personally paid on his Schedule C, rather, he would deduct those taxes on line 5a of his Schedule A (assuming he itemizes).

REAL ESTATE AGENT

Penn is a successful real estate agent based in Chicago, Illinois. Throughout the year he made estimated state tax payments on his commission income totaling $4,000. When Penn prepares his Federal taxes in April of the following year, if he itemizes his deductions he could deduct the $4,000 of Illinois taxes he paid during the prior year. Note that this is a personal Schedule A deduction for Penn, not a business Schedule C deduction.

COURIER

Last year, Emily drove for Postmates on nights and weekends to earn some extra cash. She did not pay estimated taxes during the year. In April of this year, her accountant told her she owed $1,500 in state taxes for her postmates driving. Emily was only able to pay $500 of the tax liability throughout the year last yaer, accordingly, in April of this year, when she prepares last year's return only $500 of the taxes will be deductible, assuming she itemizes her deductions.

AIRBNB HOST

Ron is an Airbnb host who rents the second bedroom in his home out on weekends. In April of this year, Ron paid state taxes on last year's rental income. Next year when Ron prepares his Schedule E for this year, he can deduct the state taxes he paid on his rental income during the prior year on line 16.

WHAT TO KNOW ABOUT STATE AND LOCAL INCOME TAX

Individual state and local income taxes paid by business owners are not deductible on Schedule C, rather, they would be deductible on Schedule A assuming the taxpayer chooses to itemize their deductions. State and local income tax payments, including estimated payments can only be deducted in the year paid.
If you choose to deduct your state and local income tax payments on your Schedule A you cannot also deduct sales taxes. You must choose one or the other. You can however deduct income taxes on your Schedule A and sales taxes paid for business activities on your Schedule C or rental activities on your Schedule E.
Refunds of state and local income taxes are not deductible unless you apply the refund to next year's taxes. Further, any interest or penalties paid along with your state and local income taxes are also not deductible.
If you do business in a state that is not your primary place of business it does not automatically mean that you will have to pay the state and local income tax for that state. Different states have different thresholds for when taxation occurs and state and local taxes vary in each locality. If you plan to do business in a different city or state you should conduct research to determine if and when you will be subject to taxes in those jurisdictions.
In addition to income taxes some states may also impose real estate taxes and personal property taxes. It is important to note that these are fundamentally different from income taxes and accordingly should not be included as part of your state and local income tax deduction.

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