Navigating the Complexities of Multi-State Tax for Painting Entrepreneurs

Welcome to the Profitable Painter Podcast. The mission of this podcast is simple: to help you navigate the financial and tax aspects of starting, running, and scaling a professional painting business. From the brushes and ladders to the spreadsheets and balance sheets, we've got you covered. But before we dive in, a quick word of caution: while we strive to provide accurate and up-to-date financial and tax information, nothing you hear on this podcast should be considered as financial advice specifically for you or your business. We're here to share general knowledge and experiences, not to replace the tailored advice you get from a professional financial advisor or tax consultant. We strongly recommend you seeking individualized advice before making any significant financial decision.

This is Daniel, the founder of Bookkeeping for Painters, and this is Richard, tax director with Bookkeeping for Painters.

How's it going?

It's going pretty good. You know, the weather is really starting to turn towards summer. I feel like I always talk about the weather on these things because I don't, I don't really have a good segue. But you know what might be a good segue for today is I'm coming from Illinois, which is a state that has a 4.95% income tax. And Daniel, what kind of income tax do you deal with in Florida?

0% income tax on the personal side. So that's one of the, one of the reasons why we're here.

Yeah, that's, that's a nice benefit. See here, in, in our country, I don't know, I should have counted this beforehand. I think there's like 8 to 10 states that don't have any kind of personal income tax. So places like Florida, Texas, Washington, Tennessee, New Hampshire, I believe, and probably missing a couple others. These are states that don't assess an income tax on your personal income, and they're kind of the exception, not the rule. Right. Because, because most places do have some kind of a statewide income tax. I don't have it too bad here in Illinois. Some of my fellow Illinoisans would probably disagree. We get hit pretty hard on property taxes, but as far as income tax goes, we're a flat almost 5%. Other places like California are graduated and I think they top out around 13% in the highest bracket. So it can be pretty significant depending on where you live.

Yeah, it definitely can make a huge difference, especially as you start making more money. It becomes a bigger and bigger thing to consider, for sure.

Yeah. And you can imagine that, you know, the states are very— oh, they, uh, they want to get paid, you know. They're, they're on it when it comes to getting their income tax. So it's not just a matter of Well, I live in Florida, therefore I pay no income tax. Because what if you live in Florida but you do business in Georgia or Alabama? Or maybe you live in Florida and you have a rental property in California? Is it just a matter of I'm a Floridian, I don't pay tax? It would be nice. California is going to disagree with you on that one. So the way it works is basically states feel that they are entitled to tax money that is earned in their state, and the accounting jargon for that is economic nexus. So you do business in our state, you use resources in our state to generate income. We're entitled to tax you on that. So if you're working as an employee in another state, your W-2 is going to show that your income was derived in that state. If you are a contractor, you might get a 1099 that shows income from whatever state you worked in. If you are a partner in a partnership or a shareholder in a corporation that's in a state other than the one you live in, you're going to get that K-1, and it's going to be a federal K-1. There's also going to be a state K-1, you know, with the income from that state. So they know, the states know where the money was earned and they're going to feel entitled to tax it. Now, just a little bit of a side point here for W-2 employees. So you, you know, work for somebody else. A lot of neighboring states have what they call reciprocal agreements to try and ease that burden on employees. So, for example, I'm in Illinois. Illinois has a reciprocal agreement with Wisconsin. And Iowa and Indiana and Kentucky. So I live in Illinois, I'm in northern Illinois. I go across the border into Beloit, Wisconsin, and I work for a factory in Beloit. My wages, even though they're earned in Wisconsin, will be taxed as if they were earned in Illinois. So I only have to file one tax return. Same thing if someone in Beloit comes down here and works in Rockford. That's for W-2 employees and only for states that have those agreements. Not all states have those agreements. So, you know, check with your local area. But now what if I'm self-employed and I cross the border and I work in Wisconsin? Now all bets are off. Now I've got economic nexus in that state and now I have to file not just my Illinois return for my resident state, I have to file a return with Wisconsin or other places, other states that I might work. So that's if you live in a state and you earn income from another one. Now, what if you live in a state like Illinois that has a tax and I earn income from Florida that doesn't have a tax? Does that mean I get to not pay taxes on that income. Well, that would seem logical. So of course that can't be the right answer. Most states feel that they have the right to tax money earned worldwide by the residents of their state. So even though my income may be derived from a tax-free area, I live in Illinois. Illinois says you have to report it and you have to pay taxes on it. So, yes, we kind of, we kind of get the worst of both ends. So you want to be aware of that. There's a kind of a good example. I'm a, I'm a big football fan. I grew up in South Florida, so I definitely love rooting for the Miami Dolphins. And when football players get traded or they get offers, they might have you know, multiple places they can land. Maybe they have an offer to play in New York or an offer to play in Miami. And sometimes they'll choose to take an offer that pays a little bit less. And the pundits will come and say, well, yeah, you know, he's taking a pay cut to go play in Miami, but there's no income tax in Florida. So therefore he'll make up what he loses by not having to pay taxes. And, you know, that's sort of true. For the 8 games that he plays, the 8 home games he plays in Miami, he won't have to pay any income tax because he's a Florida resident earning income in Florida. But what happens when he goes up to New York, you know, a few times a year to play the Jets and the Bills? Hopefully Miami wins, but he will also have to pay New York State income tax on the money that he earns from those games.

So even if he wins, he's kind of losing.

Well, it's worth it if he can beat the Bills, but that's just my opinion. I hope we don't— I hope we don't have any Bills fans in our audience. No, no, they understand. Yes, yes. If they go to New York to play the Bills, and, you know, Tyreek Hill gets $1.2 million for that game. He gets a W-2 showing income from the state of New York, and he has to pay New York income tax on that money because he has economic nexus in New York. I was talking to a tax attorney and he was telling me that he had an NBA player as a client once and he had to file 30 different state returns because the NBA player played so many games in so many different states.

Yeah.

So it just— it's a good example of like the states take this seriously and they, they're not, you know, they don't really have a lot of chill about not paying taxes.

Yeah. So really we're, we're talking to the folks that are living near a border and they have a service area that they're working in multiple states. And we also have a few clients where they have a business in one state but they're actually living in a separate state, and so they're having to deal with this issue too.

Yeah, absolutely. And, and if you live on the border of, um, let's say Virginia and West Virginia, both states have a state income tax. Whatever was earned in Virginia Virginia wants its cut. Whatever was earned in West Virginia, West Virginia wants their cut. Something else to consider is that this applies not just to business income, but it can also apply to capital gains and passive income. So maybe you buy a, you know, a property, a rental property in California. You live in Florida, you buy a property in California. Your rental income from that property is subject to California taxes. If you sell that property at a gain, that gain is subject to California taxes. How will California know? Well, hopefully your rental property is in some kind of an LLC because you are going to need that asset protection. And in order to operate an LLC in a different state, you have to register in that state. So yes, they know. This also applies to like sales tax, which we won't really get into today. But you've got nexus. Make sure that you're paying sales tax in that state as well. If the state taxes the services you're, you're selling. Another thing to consider, depreciation. So, you know, we've talked a lot about accelerated depreciation. Bonus depreciation, which is kind of phasing out now. Section 179 depreciation, which has been around for a while. You know, this allows us to write off things like vehicles and, you know, equipment and machinery and take big tax deductions on our federal tax return. The states don't usually play the same game as the IRS. So a lot of states will say, you know, bonus depreciation, that's great for Uncle Sam, but, you know, here in our state we use straight line. So your state taxes are calculated differently and whatever state you earn the money in is the state whose rules you're going to have to play by. So I think, I think the natural question is like, okay, well, this sucks. What if I live in a state with the state income tax and I do business in a state with an income tax? Am I going to get taxed twice? The answer is mostly no. A lot of states offer like tax credits so that you don't get taxed twice. And of course, they do this in the most convoluted, confusing way possible where you usually report all of your income to your state and then tease out what was earned in another state, figure out how much taxes you paid to other states, and then take that amount as a credit on your resident state return. So I know that was a bit of a mouthful and it can be very, very confusing, but at least you're generally not paying double taxation, uh, you know, when you have two different or multiple states with an income tax.

Yeah. And so I think the takeaway is to make sure you're covered if you're— because when, when you're audited, because it's always a question of when, not if, if you're in business long enough. And I think most folks in this trade are going to be in, in it for the long, the long haul, for decades, right? So when you get audited, you need to have your books in line and track where the income is coming from, which state. If you're living on one of those border states, you're doing jobs in multiple states, whatever the case is, you need to make sure your books reflect what income is coming from what state. And, and in QuickBooks Online, if you're using QuickBooks Online, your customers should have an address in there of where they're living in. And so you should be able to pull a report based off that if, but you got to be invoicing out of QuickBooks Online or syncing invoices over to QuickBooks Online that has the address in there so that you can pull that income data on how much money did you, you know, earn in Florida versus Georgia or whatever the case is.

Yeah, that class tracking and teasing it out is extremely important because you will need to allocate it between the different states. So, you know, we talked a lot about if you earn money in different states, you know, how that's going to affect you. What if you are the president of an S corp or you're the managing partner of a partnership and you have nonresident shareholders? So, for example, You are running an Illinois S corp earning income in Illinois, and one of your shareholders lives in Tennessee. How is that handled? Well, Illinois knows that some of its revenue is going to a Tennessee resident, and they're worried that the Tennessee resident might not file taxes and might not pay Illinois its share. I mean, you know, they're not used to filing individual state income tax. So, you know, they might not do it. And it's difficult for Illinois to go after someone who's not a resident of their state. So what the states will generally do is they'll say, okay, we're going to push the burden onto the S corp or the partnership or whatever the entity is that earned the income. So you'll file an S corp or partnership return with Illinois or, or whatever state it is. And that state, depending on its rules, might require you to withhold some of that shareholder's money and remit it to the state. It's kind of like forcing you to do estimated payments for that nonresident shareholder. So, for example, if your partner Bob, who lives in Tennessee, earns $100,000 from the Illinois S corp, Illinois might say, okay, our tax rate's 5%. We want the S corp to remit 5%, $5,000 to Illinois. And when Bob files his Illinois nonresident return, then will true it up and maybe we'll owe him a little bit of a refund. But if Bob never files his return, the state's like, we got paid. So that's something to be, you know, taken into consideration if you have the responsibility of filing the taxes for a corporation. Another thing they might do is allow you to file what's called a composite return, where it's— and this usually kicks in when there's more than one nonresident shareholder. And that's basically allowing Bob to file his individual Illinois taxes with the Illinois S corp return. Not all states allow this, but some do. It takes some of the reporting burden off of your nonresident shareholders. So that's something that you can talk to your tax professional about. You know, if you're overseeing an entity like an S corp or a partnership. But I think the, the bottom line here is that the states have been collecting taxes for a long time, and they know a lot of the tricks, and they know a lot of the ways that things fall through the cracks, and they are working very hard to seal up those cracks because they want to be able to earn as much revenue as possible. So if you're doing business in more than one state, it's very important to understand One, how much of your business is allocated to each state? Like Daniel, you were mentioning class tracking and QBO is an excellent way of doing it. And then two, how are these states going to tax the money? What are the filing requirements? You may need to make estimated payments to us, to a nonresident state if you're earning money over there. If I've got nonresident shareholders, what are their obligations? Am I required to withhold on their behalf? It can get really tricky really fast. And that's without even discussing what qualifies as economic nexus and do I actually have to file a return. So, you know, definitely talk to a trusted tax professional, someone who has experience with nexus with different states. You know, your local CPA is probably really awesome. In that locality. But unless he does returns nationwide and is familiar with, like, the requirements of many different states, he might not know that Wisconsin requires you to withhold from nonresident shareholders, or, you know, he may not know that California has a different depreciation schedule than federal. So finding someone experienced in all 50 states, uh, is, is a good recommendation. Awesome.

All right, so love to hear your thoughts on this episode. If you go to Grow Your Painting Business in Facebook and join that group, love to hear your thoughts on the episode. Or if you have any ideas for future episodes, definitely let us know. And with that, we'll see you next week.

Yeah, thanks for listening and have a great rest of your day.