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Grow Your Business Finances

The 10 Best (and Worst) States for Small Business Taxes

The 10 Best (and Worst) States for Small Business Taxes
Credit: RawPixel/Shutterstock

The amount of state and local taxes you pay each year can have a huge impact on your business's bottom line. That's why it is important to know the type of tax burden you are facing when deciding where to launch your business.

A new study from Fundera revealed that Alaska and South Dakota are the best states for small businesses taxes, while New Jersey and New York are the worst.

"There are certainly other factors entrepreneurs should consider when deciding where to open up shop — population growth, access to capital, local laws, competitors, and so on — but looking at tax data is a great place for an aspiring business owner to start," wrote Ben Johnson, a content marketing manager for Fundera, on the company's blog. "If you choose to locate your business one state over, you could save thousands a year in taxes and hundreds of thousands over the course of your career."

To determine the best and worst states for small business taxes, researchers primarily focused on tax burden, which is calculated by looking at the total amount in taxes residents of a state pay and then dividing that amount by the state's total income. The tax burden shows the percent of total income an average business owner is paying toward taxes, rather than simply their income tax rate. [Paying Taxes? How to Choose the Best Tax Software]

"Tax burden is an important measure for small business owners — it shows what percentage of their income they are spending on taxes rather than reinvesting in their own companies," Johnson wrote. "With less of their income going to local and state taxes, entrepreneurs have more capital to reinvest in their business and potentially start new business ventures."

This index includes 26 individual tax measurements, including taxes for income, property, sales, motor fuels, alcohol and death.

For the study, researchers started with the average salary for a small business owner in the United States: $76,010. They then applied the maximum possible deduction for single individuals, which varied from state to state, to determine the taxable income for the average business owner in that state.

The study's authors then multiplied the taxable income by the state's tax burden to figure out what the average entrepreneur would pay in state and local taxes.

"And since over 90 percent of U.S. businesses are pass-through entities (sole proprietorships, partnerships, LLCs, and S Corps), these businesses report their income on the business owners' tax returns but are taxed on the individual income tax," Johnson wrote. "So to calculate how much the average small business owner pays in taxes, we were able to look exclusively at individual taxes rather than business taxes."

Based on the data, these are this year's best states for small business taxes:

1. Alaska

  • Average small business owner state and local taxes: $4,930.42
  • State tax burden (as percent of income): 6.5 percent
  • Top state income tax bracket: No state income tax

2. South Dakota

  • Average small business owner state and local taxes: $5,391.10
  • State tax burden (as percent of income): 7.1 percent
  • Top state income tax bracket: No state income tax

3. Louisiana

  • Average small business owner state and local taxes: $5,422.16
  • State tax burden (as percent of income): 7.6 percent
  • Top state income tax bracket: 6 percent

4. Wyoming

  • Average small business owner state and local taxes: $5,428.41
  • State tax burden (as percent of income): 7.1 percent
  • Top state income tax bracket: No state income tax

5. Tennessee

  • Average small business owner state and local taxes: $5,584.58
  • State tax burden (as percent of income): 7.3 percent
  • Top state income tax bracket: 5 percent

6. Texas

  • Average small business owner state and local taxes: $5,759.25
  • State tax burden (as percent of income): 7.6 percent
  • Top state income tax bracket: No state income tax

7. South Carolina

  • Average small business owner state and local taxes: $5,877.73
  • State tax burden (as percent of income): 8.4 percent
  • Top state income tax bracket: 7 percent

8. New Hampshire

  • Average small business owner state and local taxes: $5,987.03
  • State tax burden (as percent of income): 7.9 percent
  • Top state income tax bracket: 5 percent

9. Oklahoma

  • Average small business owner state and local taxes: $6,011.25
  • State tax burden (as percent of income): 8.6 percent
  • Top state income tax bracket: 5 percent

10. New Mexico

  • Average small business owner state and local taxes: $6,073.59
  • State tax burden (as percent of income): 8.7 percent
  • Top state income tax bracket: 4.9 percent

On the flip side, New Jersey and New York are the worst states for small business taxes, because the research shows that business owners who live there pay almost twice as much as they would if they lived somewhere else.

These are the 10 worst states for small business taxes in 2017:

1. New Jersey

  • Average small business owner state and local taxes: $9,279.68
  • State tax burden (as percent of income): 12.2 percent
  • Top state income tax bracket: 8.97 percent

2. New York

  • Average small business owner state and local taxes: $8,652.48
  • State tax burden (as percent of income): 12.7 percent
  • Top state income tax bracket: 8.82 percent

3. Illinois

  • Average small business owner state and local taxes: $8,349.68
  • State tax burden (as percent of income): 11 percent
  • Top state income tax bracket: 3.75 percent

4. Maryland

  • Average small business owner state and local taxes: $8,073.92
  • State tax burden (as percent of income): 10.9 percent
  • Top state income tax bracket: 5.75 percent

5. California

  • Average small business owner state and local taxes: $7,883.32
  • State tax burden (as percent of income): 11 percent
  • Top state income tax bracket: 13.3 percent

6. Massachusetts

  • Average small business owner state and local taxes: $7,805.71
  • State tax burden (as percent of income): 10.3 percent
  • Top state income tax bracket: 5.1 percent

7. Connecticut

  • Average small business owner state and local taxes: $7,760.00
  • State tax burden (as percent of income): 12.6 percent
  • Top state income tax bracket: 6.99 percent

8. Pennsylvania

  • Average small business owner state and local taxes: $7,743.42
  • State tax burden (as percent of income): 10.2 percent
  • Top state income tax bracket: 3.07 percent

9. Oregon

  • Average small business owner state and local taxes: $7,642.56
  • State tax burden (as percent of income): 10.3 percent
  • Top state income tax bracket: 9.9 percent

10. Minnesota

  • Average small business owner state and local taxes: $7,560.69
  • State tax burden (as percent of income): 10.8 percent
  • Top state income tax bracket: 9.85 percent

The study's authors admit that there were some limitations to the research. They said it is difficult to define the average business owner, since salaries differ by industry, location within a state and a business owner's experience.

In addition, applying a maximum deduction assumes that all small business owners only deduct the standard deduction from their incomes.

"But many business owners have deductions, exemptions, and credits that decrease the amount of taxes they pay," Johnson wrote. "To compare states, we needed a control for the study — so we assumed the typical small business owner takes the maximum deduction available for a single filer."

You can find specifics on tax burden and maximum deductions for each state on Fundera's website.

Chad Brooks

Chad Brooks is a Chicago-based writer who has nearly 15 years' experience in the media business. A graduate of Indiana University, he spent nearly a decade as a staff reporter for the Daily Herald in suburban Chicago, covering a wide array of topics including, local and state government, crime, the legal system and education. Following his years at the newspaper Chad worked in public relations, helping promote small businesses throughout the U.S. Follow him on Twitter.