SOP for Reviewing and Handling State Tax Settings in the U.S.

Understanding and adhering to state tax regulations is a critical aspect of operating a business within the United States. Each state has its unique tax laws, making the review and handling of state tax settings a complex but essential task. This Standard Operating Procedure (SOP) will outline the systematic approach you can take to ensure compliance and accuracy in managing state tax settings for operations across various U.S. states.

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Overview of U.S. State Tax Regulations

Generally, in the United States, there are diverse federal, state, local, and specialized governmental taxing authorities aimed at funding each’s operations, either fully or partially. These taxes may target income, property, or specific activities, often without any offset or credit against other taxes. The types of taxes levied by each level of government vary, partly due to constitutional constraints. 

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For instance, income taxes are common at the federal and state levels, while property taxes typically fall under the purview of local governments, albeit multiple local jurisdictions may impose taxes on the same property. Additionally, excise taxes are imposed by the federal government and some states, whereas sales taxes are prevalent across most states and many local jurisdictions.

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For businesses, corporations are subject to taxation on their net income by the federal government, as well as by most state and some local governments. While most business expenses are deductible, there are limitations on certain deductions. States often have their own regulations for calculating taxable income, which may differ from federal guidelines. 

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For instance, while Federal marginal tax rates range from 10% to 37%, State and local tax rates vary significantly across jurisdictions, ranging from 0% to 13.30% of income, with many using a graduated scale.

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State taxable income is determined according to state legislation and often mirrors federal taxable income. Many states adopt numerous federal concepts and definitions, including those pertaining to income, business deductions, and their timing. However, there is considerable variation among states regarding individual itemized deductions. 

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So, what are the specific types of tax levied at the state level for businesses, according to the IRS? 

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1. Corporate Income Tax: Most states levy a corporate income tax on the profits earned by corporations operating within their borders. The tax rates and tax brackets vary by state, and some states use a flat rate while others have a graduated rate structure. Every business entity, excluding partnerships, is required to submit an annual income tax return, while partnerships are obligated to file an information return. The specific form to be used is determined by the organizational structure of your business.

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Corporate income tax forms include:

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• Schedule C (Form 1040), Profit or Loss From Business
• Schedule E (Form 1040), Supplemental Income and Loss for partnerships
• 1120, U.S. Corporation Income Tax Return for C corporations
• 1120-S, U.S. Income Tax Return for an S Corporation
• Schedule K-1 (Form 1120-S) for S corporations

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2. Estimated Tax: Independent contractors, entrepreneurs operating solo, partnership members, and shareholders of S corporations must make estimated tax payments if they expect to owe $1,000 or more upon filing their tax returns. Corporations generally have to make estimated tax payments if they expect to owe tax of $500 or more when their return is filed. 

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3. Employment Taxes: Businesses are responsible for withholding and remitting state income taxes from employee wages, as well as paying state unemployment insurance taxes and workers' compensation insurance premiums. Employment taxes include the following:

• Social Security and Medicare taxes
• Federal income tax withholding
• Federal unemployment (FUTA) tax

4. Excise Taxes: Some states impose excise taxes on specific goods or activities, such as alcohol, tobacco, gasoline, motor fuels, or certain business transactions. These taxes are often included in the purchase price of the item or service and are collected by businesses on behalf of the state.

There are 3 excise tax forms to fill depending on…

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• Form 720: Form 720 encompasses federal excise taxes, which are classified into various broad categories, including but not limited to the following:

• Environmental taxes.
• Communications and air transportation taxes.
• Fuel taxes.
• Tax on the first retail sale of heavy trucks, trailers, and tractors.
• Manufacturers taxes on the sale or use of a variety of different articles

• Form 2290: A federal excise tax is imposed on specific trucks, truck tractors, and buses utilized on public highways, applicable to vehicles with a taxable gross weight of 55,000 pounds or greater. This tax is reported on the form 2290
• If you engage in accepting wagers or organizing wagering pools or lotteries as part of your business activities, you could potentially be responsible for the federal excise tax on wagering. You would use Form 730 to calculate the tax owed on the wagers you receive.
• To register for any wagering activity and fulfill the federal occupational tax obligation related to wagering, utilize Form 11-C, Occupational Tax and Registration Return for Wagering. 

5. Self-employment tax: The self-employment tax (SE tax) is a vital component funding your coverage within the Social Security system, ensuring benefits like retirement, disability, survivor, and Medicare. Sole proprietors and independent contractors fulfill their tax obligations by completing Schedule SE, which accompanies either Form 1040 or Form 1040-SR.

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6. Franchise Tax: Some states impose a franchise tax, also known as a privilege tax or capital stock tax, on corporations for the privilege of doing business within the state. The franchise tax may be based on a corporation's net worth, capital stock, or some other measure of business activity.

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Variance in tax regulations across different U.S. states.

Tax regulations across different U.S. states vary significantly due to each state's autonomy in setting its tax policies. Variance can be observed in tax rates, types of taxes imposed (e.g., income tax, sales tax, property tax), deductions and credits available, treatment of certain income types, thresholds for taxation, and administrative procedures. 

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Some states may have specific tax incentives or exemptions aimed at attracting businesses or residents. Overall, the diversity in tax regulations reflects the unique economic, social, and political priorities of each state.

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Each state within the United States operates its own tax administration, adhering to the specific regulations outlined by state laws. These entities are commonly known as the Department of Revenue or Department of Taxation across most states. 

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The authority and scope of these state taxing bodies differ significantly, with many responsible for enforcing statewide taxes while overlooking local tax collections. Nonetheless, several states have streamlined their sales tax administration at the state level, encompassing local sales taxes as well.

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Taxpayers file their state tax returns directly with these state tax administrations, distinct from federal tax authorities. Procedural guidelines for tax filings vary considerably from state to state.

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Legal and financial repercussions of non-compliance with US state tax laws.

• Interest and penalties: Failure to submit your business taxes promptly can lead to fines, penalties, and owed back taxes if you become delinquent
• Audits and Investigations: Non-compliance may trigger audits or investigations by state tax authorities. These processes can be time-consuming, disruptive, and costly, as taxpayers may need to provide extensive documentation and explanations for their tax filings.
• Liens and Levies: State tax authorities have the power to place liens on property or levy bank accounts or wages to collect unpaid taxes. These measures can severely impact an individual's or business's financial stability and creditworthiness.
• Loss of Licenses or Permits: Some states may revoke or suspend business licenses or permits for non-compliance with tax laws. This can disrupt business operations and damage reputation and credibility in the market.
• Damage to Reputation: Public knowledge of tax evasion or non-compliance can damage an individual's or business's reputation and credibility. This can have long-term consequences on relationships with customers, suppliers, and business partners.
• Difficulty in obtaining a loan: Failure to comply with tax laws may make it difficult to get financial assets such as loans and grants when needed. 

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A few tax facts you should know

• In 2020, tax revenues collected by federal, state, and local governments accounted for 25.5% of GDP, falling below the OECD average of 33.5% of GDP. 
• Following the enactment of the Inflation Reduction Act of 2022,   large corporations are now subject to a 15% minimum tax based on annual financial statement income. 
• Among the states in the US, forty-seven impose income taxes on corporations, while eight states—Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, Washington, and Wyoming—levy no state income taxes.
•  The Corporate Transparency Act (CTA), passed in 2021, aims to enhance transparency regarding entity structures and ownership, addressing concerns such as money laundering and tax fraud. Its objective is to gather comprehensive ownership information for entities operating within or accessing the U.S. market. It has now been effective since January 2024. 

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Step-by-Step Procedure for State Tax Review Filing 

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Step 1: When getting ready for tax preparation, it's essential to gather certain documents pertinent to your small business, such as:

include:

• Invoices
• Paid and outstanding bills
• Canceled checks
• Deposit slips 
• Sales slips 
• Cash register tapes
• Credit card statements
• Bank account statements
• Employment tax records

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While many businesses necessitate an Employer Identification Number (EIN) for tax filing purposes, not all do. The IRS specifies that you must apply for an EIN if any of the following criteria apply to your business

• You have employees.
• Your business is a corporation or partnership.
• You have a Keogh (tax-deferred pension) plan.
• You withhold taxes on income paid to a nonresident alien.
• You file Employment, Excise, or Alcohol, Tobacco, and Firearms tax returns.
• You are involved with certain trusts, estates, real estate investments, nonprofits, farmers’ cooperatives, or plan administrators.
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Step 2: Know what type of company your business falls into and what form to fill: First, determine whether your corporation falls under the classification of a C corporation or an S corporation. By default, a corporation in the U.S., excluding LLCs, is designated as a C corporation. However, once your company is established as a C corporation, you have the opportunity to opt for S corporation status. This election enables tax obligations to pass through to the owners' tax  returns. C corporations utilize Form 1120 for filing federal income taxes, whereas S corporations employ Form 1120-S
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Once you are cleared on this, the next step is to determine which of the taxes listed above you want to fill and pick the respective form. 
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Step 3: the next step in corporate tax return preparation involves identifying eligible tax deductions for write-off. Corporations, as permitted by the IRS, can deduct a range of expenses crucial for business operations. These may encompass current operational costs, specific investments and real estate acquisitions, employee wages and benefits, certain taxes, insurance premiums, and other qualifying expenditures.
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Step 4: Next, calculate the anticipated tax obligation on the net income. For C corporations, submit estimated tax payments quarterly to both state and federal authorities. S corporations, which typically pass tax obligations to shareholders, usually don't pay income taxes and thus don't make estimated tax payments. However, S corporations must make estimated tax payments if their tax liabilities for built-in gains, excess net passive income, and investment credit recapture exceed $500. Additionally, C corporations generally must make estimated tax payments to one or more states.
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Step 5: Fill out your chosen tax forms, following the procedures provided by the IRS for each form. 
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Step 6: File your tax before the deadline. While traditionally, many states mandated that corporations file their income tax returns concurrently with their federal taxes, this practice is evolving. Several states are now adjusting their deadlines to be one month or even later, allowing taxpayers additional time to finalize their federal returns, upon which the state returns are dependent.
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For this year, the deadline for filing taxes falls on April 15, 2024. Should you require an extension by this date, your tax return deadline extended to October 15, 2024. It's important to note that tax extensions provide additional time for filing your return, not for paying your taxes. Even with an extension, your tax payment remains due on April 15.
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You can get the full schedule from the IRS 2024 General Instructions on Certain Information Returns. 

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Best Practices for  Quality Assurance and Compliance Checks during reviews
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1. Schedule SOP Reviews: Tax teams encounter numerous obstacles when striving to accurately prepare and file tax returns. Staying abreast of frequent alterations in tax rules and regulations across various jurisdictions is imperative. This task becomes especially daunting for companies with operations in multiple states, necessitating tax filings across numerous jurisdictions. Triggers for reviews could be any of these;

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• Legislative Changes: Immediately conduct reviews in response to significant legislative or regulatory changes at the state level to ensure prompt compliance. However, you may also want to stay abreast of Federal-level updates, as they may also affect state taxation. 
• Company Expansion: Initiate reviews when the company undergoes significant expansion, such as entering new markets or jurisdictions, to assess the impact on tax settings and compliance requirements.
• Major Financial Events: Perform reviews following major financial events like mergers, acquisitions, or restructuring to evaluate the implications for tax settings and optimize tax planning strategies.
• Audit Findings: Trigger reviews in response to audit findings or internal assessments that highlight potential discrepancies or areas for improvement in tax settings.
• Industry Changes: Conduct reviews in response to significant changes within the industry or market dynamics that may affect tax obligations or strategies.
• Technology Upgrades: Initiate reviews when implementing new accounting or tax software systems to ensure seamless integration and accuracy of tax settings.
• Management Changes: Perform ad-hoc reviews following significant changes in management or key personnel responsible for tax compliance to maintain continuity and ensure adherence to established policies and procedures.

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2. Internal Audits: internal audits are necessary to check the accuracy of the tax settings and the effectiveness of the review process.

• Clearly define the objectives of the internal audit. This may include ensuring compliance with tax regulations, identifying any errors or discrepancies in tax settings, and assessing the effectiveness of the review process in place.
• Determine the scope of the audit, including the specific tax settings and processes to be examined. This may involve reviewing tax calculations, exemptions, deductions, credits, and other relevant factors. Establish criteria for evaluating the accuracy and effectiveness of the tax settings and review process.
• Collect relevant information and documentation related to tax settings, such as tax returns, financial records, accounting systems, and internal policies and procedures. This may also include documentation of the review process, such as records of reviews conducted and any findings or recommendations made.
• Conduct testing to verify the accuracy of tax settings and the effectiveness of the review process. This may involve sample testing of transactions, reconciliations, and other relevant data to ensure compliance with tax regulations and internal policies.
• Identify any errors, discrepancies, or deficiencies in tax settings or the review process. This may include inaccuracies in tax calculations, missing documentation, inadequate controls, or weaknesses in the review process.
• Assess the risks associated with identified issues and deficiencies, including potential financial, legal, and reputational impacts. Prioritize findings based on the level of risk and potential impact on the organization.
• Based on audit findings, make recommendations for corrective actions and improvements. This may include updating tax settings, implementing additional controls or procedures, providing training to staff, or enhancing documentation practices.
• Present audit findings, conclusions, and recommendations to relevant stakeholders, such as management, tax professionals, and internal audit committees. Clearly communicate the rationale behind findings and recommendations, as well as any potential implications for the organization.
• Work with management and relevant stakeholders to implement recommended corrective actions and improvements. Monitor progress and ensure that identified issues are addressed in a timely and effective manner.

3. External Consultation: When necessary seek external consultation from tax professionals or legal advisors to validate the company's tax settings. You may;

•  Pinpoint tax planning strategies, compliance with laws, complex tax matters, or audit support.
• Find experts in tax law and regulations, considering qualifications, reputation, and success.
• Reach out to discuss needs, availability, and willingness to consult. Schedule meetings to discuss scope, timeline, and fees.

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4. Resource Repository: maintain a centralized repository of tax resources, guidelines, and contacts for easy access. You may have to; 

• Choose a digital platform (shared drive, cloud, or specialized system) for tax documents. Organize resources into categories like laws, deadlines, forms, strategies, and contacts.
• Gather comprehensive tax guidelines and create a directory of key contacts, including advisors and government agencies, ensuring easy access for stakeholders.
• Grant access based on roles, updating permissions regularly for security. Implement version control to track document revisions, ensuring users have the latest information.

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In addition, it is essential to maintain comprehensive documentation of the consultation process, encompassing meeting notes, correspondence, and agreements or contracts with advisors. This documentation serves to uphold accountability and serves as a record of the company's endeavors to validate its tax settings. Additionally, conducting regular training sessions is crucial to keeping relevant staff informed about state tax laws and internal procedures, fostering ongoing compliance and efficiency within the organization.

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FAQs

1. What’s the difference between fixed and graduated taxes?

Answer: Fixed taxes, also known as flat taxes, impose a uniform tax rate on all taxpayers regardless of income, while graduated taxes, or progressive taxes, apply different tax rates based on income levels, with higher earners facing higher rates. Fixed taxes offer simplicity and uniformity but may be seen as less equitable, while graduated taxes aim for fairness by taxing higher incomes more heavily

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2. What if I owe taxes and can’t pay yet? 

Answer: You have the option to request an extension of 60-120 days to pay through the Online Payment Agreement application or by calling the IRS, with no associated user fee. Alternatively, if you require an extended repayment period, you can request an installment agreement, or you might be eligible for an offer in compromise.

3. What if I don’t know if my company is C corporate or S Corporate? 

Answer: If you don’t know what kind of corporation your business is, call the IRS Business Tax Line . The IRS can tell you whether you should file taxes as a C corporation or an S corporation.

Note: Our content is for general information purposes only. Levy does not provide legal, accounting, or certified expert advice. Consult a lawyer, CPA, or other professional for such services.