The 5 Least Tax-Friendly States for Running a Business

Let's face it: None of us enjoys paying our taxes, but without this crucial economic component we simply wouldn't have money to employ our government officials, pay for our military, or offer government-sponsored social programs such as Social Security and Medicare, to name a few things.

However, as much as we'd like to believe as individuals that paying our taxes is painful, tax rates can actually be much more painful for businesses that can owe millions, or billions, in taxes each year. Consider technology giant Apple (AAPL 0.68%), for example, which set aside $13.12 billion for income taxes in 2013 at an effective tax rate of 26.2%. This was amazingly down from the $14.03 billion it set aside in 2012.

All things considered, though, Apple's effective tax rate is nowhere near the peak corporate tax rate of 39.1%, which is 14% higher than the average corporate tax rate, according to the Organisation for Economic Co-Operation and Development for OECD countries. In other words, American corporations have quite the tax mountain to climb each and every year.

Source: Jarmoluk, Pixabay.

The five least tax-friendly states to run a business
Now here's the really interesting thing about tax rates: They can vary wildly by state. In this instance I'm talking about the varying combinations of corporate taxes, sales tax, individual income tax, unemployment insurance tax, and property taxes as well. "What does this mean for businesses?" you may be wondering. It means that states need to pick and choose where they incorporate wisely, as corporate taxes and taxes on local consumers can have a discernible impact on their overall performance.

If you think about it, states with high property and individual taxes could constrain consumer spending and discourage people to move to a particular state, while higher corporate taxes may discourage incorporation in that state.

Thankfully for us, the Tax Foundation recently released its findings (link opens a PDF, Table 4) as to which states stack up as the best and worst in terms of overall economic performance based on the aforementioned five tax categories, with lower numbers representing a more favorable state to operate in for businesses. Today, we're going to look at which states brought up the bottom of that list, discuss some of the factors that pushed them to the caboose, and suggest a few ways this information could make us smarter investors.

Without further ado, here are the five least tax-friendly states to run a business:

Source: Tax Foundation, states are ranked 1-50 where lower numbers are more favorable, based on 2013 figures. 

Why these states rank at the bottom
Those states consistently rank toward the bottom in a number of key categories that would discourage business incorporation or consumer spending.

Source: Eli Christman, Flickr.

For instance, with the exception of California, we have four of the worst six offenders listed with regard to the highest property taxes in America. Remember, both individuals and businesses have to pay property taxes. Higher property taxes lessen consumers' disposable income and could reduce a company's ability to expand and hire.

These states are also notorious offenders when it comes to individual incomes taxes, with four of the bottom five states represented, the exception being Rhode Island. Similar to property taxes, more money out of consumers' pockets means less opportunity for businesses to market to local consumers.

With the exception of New York, which has taken aggressive steps to maintain lower corporate tax rates and has offered new business that'll incorporate in the state tax-free status for 10 years, the remaining four states -- New Jersey, California, Vermont, and Rhode Island -- all rank in the bottom 11 in terms of highest corporate tax rates.

How knowing these facts can help you invest better
I admit that I'm a numbers guy who loves to seek out obscure facts. This instance is also one of those cases where the interesting and obscure facts could also serve to help us invest better.

Take investment banking giant Goldman Sachs (GS 0.04%) as a good example. Although Goldman Sachs has offices around the world, it's based out of New York, the least-friendly overall state based on the Tax Foundation's rankings, employing about 25% of its global workforce in the state. You'd certainly be hard-pressed to say that Goldman Sachs is struggling, having earned $7.7 billion in net income in 2013, but it still paid 31.5% of its pre-tax earnings ($3.7 billion) to taxes, as well as another $839 million in occupancy expenses (rent, utilities, and so on). If Goldman weren't so tied to Wall Street's surroundings, it could likely save itself tens, if not hundreds, of millions of dollars by incorporating in another state.

Another company that can partially suffer from this tax bias is grocery chain Weis Markets (WMK -0.19%), which is based in Pennsylvania, but operates grocery stores throughout New Jersey and New York. As you can see from the data, New York and New Jersey have some of the highest sales tax rates out of the 50 states, which is something that can discourage shoppers from spending more. With the grocery business running on already razor-thin margins, it's conceivable that the lesser-favorable tax situation in the Northeast could hold Weis' growth capabilities back.

Although I'd be reluctant to suggest that you base an investment decision on a cumulative tax rates paid, it can give you a good idea of where corporate money is headed and give you those little edges that can take you from being a good investor and transform you into an extraordinary one.