Introduction
Forming an S corporation in a state with low or no individual income tax does not make your state tax bill disappear. State obligations usually follow where the business operates, employs people and sells, not where the paperwork was filed.
An S corporation is a US federal tax election, not a business type in Australia. This guide covers US state income, franchise, pass-through entity (PTE), payroll, sales/use and property obligations, and how they interact with Australian ownership.
For example:
- California charges S corporations 1.5% of California-source income, generally with a $800 minimum
- New York requires a separate state election
- Texas applies franchise tax reporting by entity status and activity, not federal S status
We cover how states treat S corps, nexus, how to pick a state, and a practical filing plan.
Key Takeaways
- S status is a federal election; each state may recognise, modify or reject it.
- The formation state is one factor; operations, staff and sales create obligations elsewhere.
- Entity-level, franchise, payroll, sales/use and local taxes can apply despite pass-through income.
- Nonresident aliens cannot hold S shares, so check eligibility before choosing the structure.
What S Corporation Status Means Before You Assess State Taxes
An S corporation is a domestic corporation, or an eligible domestic entity electing corporate treatment, that makes a Subchapter S election. It is not a separate state-law entity type.
The business files Form 1120-S, and each shareholder receives a Schedule K-1. Shareholders pay tax on allocated income whether or not it is distributed.
Federal eligibility rules that matter to Australians
According to the IRS S corporation guidance, the entity must meet these tests:
- Domestic entity with no more than 100 shareholders
- Shareholders limited to US citizens, resident aliens and certain trusts, estates and exempt organisations
- No partnerships, corporations or nonresident aliens as shareholders
- One class of stock (voting differences are disregarded)
An Australian who is a US nonresident alien cannot directly hold S shares. Nationality alone does not disqualify someone; US tax residency status determines eligibility.
Federal election is not state election
Filing Form 2553 does not guarantee every state will recognise the election. The election needs shareholder consent and is normally due within two months and 15 days of the tax year's start. Late-election relief exists but is conditional.
Some obligations sit at business level regardless:
- Payroll and employment taxes
- Sales/use and property taxes
- Franchise, minimum and excise taxes
- Built-in gains tax after prior C corporation status (generally a five-year recognition period)
How it compares with an LLC or C corporation
An LLC under default rules is also pass-through but has no shareholder restrictions in the same way. A C corporation pays entity-level tax and has no ownership limits. For an Australian owner, the ownership restriction usually decides the question, so get tailored advice first.
How US States Tax S Corporations
States generally fall into three groups:
- Those that follow the federal S election
- Those requiring a separate election or filing
- Those that do not fully conform
Always confirm current rules with the relevant state revenue department.
State examples
| Jurisdiction | Treatment |
|---|---|
| California | 1.5% of California-source income; generally $800 minimum |
| New York State | Separate CT-6 election; receipts-based fixed-dollar minimum tax |
| New York City | Does not recognise S elections; General Corporation Tax may apply |
| Illinois | 1.5% replacement tax instead of corporate income tax |
| Tennessee | 0.25% net worth franchise tax ($100 minimum); 6.5% excise tax |
| New Hampshire | Corporate treatment: 7.5% business profits tax; 0.55% enterprise tax |
A state with "no corporate income tax" is not a state with no tax.
Shareholder-level tax and withholding
State-source income flows to resident and nonresident shareholders, who may file in more than one state.
- California generally requires 7% withholding on California-source distributions to nonresident shareholders above $1,500 a year, with exemptions
- Illinois applies pass-through withholding unless the entity elects PTE tax for all owners
- New York may require estimated payments for nonresident individual shareholders
Pass-through entity tax (PTET)
Under IRS Notice 2020-75, qualifying state income taxes paid by an S corporation are deductible at entity level, outside the individual SALT limit. The 2026 individual cap is up to $40,400, reduced above $505,000 MAGI but not below $10,000.
- California elective rate: 9.3%; 15 June payment of the greater of $1,000 or 50% of prior-year elective tax
- New York: annual election by 15 March
- Illinois: 4.95%, in addition to the replacement tax
AICPA counted 36 states and one locality with PTE taxes as at 26 January 2026. Check deadlines each year.
Taxes beyond income
Sales/use, employer payroll, unemployment, property, excise and local taxes also apply. For example, a Texas S corp under the $2.65M no-tax-due threshold may owe no franchise tax, yet still files information reports, runs payroll and collects sales tax.
S Corp Nexus and Multi-State Obligations
Nexus is a sufficient connection to a state to trigger filing or registration. Offices, employees, remote workers, inventory, property, services and sales can all create it. Income, sales and payroll tax nexus are separate tests.
- Sales tax: After Wayfair (2018), physical presence is no longer required. South Dakota uses a $100,000 sales threshold.
- Income tax: P.L. 86-272 protects only solicitation of orders for tangible goods, not services or other tax types.
- Remote staff: Regular teleworking in a state is generally unprotected, and New Jersey confirms a home can create physical nexus.
Incorporating in one state, operating in another
Operating elsewhere typically means foreign qualification, a registered agent, annual reports, extra state returns and withholding. Those filing and agent costs often stack. Texas notes that its tax-nexus threshold is generally lower than its registration threshold.
Sourcing and apportionment
Multi-state S corps apportion income by state rules, and the results flow to shareholders on K-1s. Many states are moving to single-sales-factor apportionment and market-based sourcing, so service receipts may follow the customer, not the employee. Verify each state's rules.
Scenario: Australian-owned business, low-tax formation state
Say a US-resident shareholder group, with an Australian investor involved through an eligible structure, forms a company in Wyoming but employs a team in California.
Wyoming's formation is cheap, but California payroll, California-source income tax, registration and nonresident shareholder withholding can all apply. The formation state did not remove the operating state's claim.
How to Evaluate the Best State for an S Corporation
There is no universally best state. If the business has real presence in its home state, forming there is often simplest. Forming elsewhere can add foreign qualification and double compliance.
A decision framework
Compare:
- Whether the state recognises S status
- Individual and entity-level taxes
- Franchise or minimum taxes
- PTET availability
- Filing complexity, payroll and sales-tax rules
- Annual fees and registered-agent costs
- Workforce location and expansion plans
Commonly considered states (examples only)
| State | Formation / recurring | Tax note |
|---|---|---|
| Delaware | From $109; $50 annual report; franchise tax from $175 | Due 1 March |
| Nevada | Articles from $75; $500 business licence | Commerce Tax above $4M revenue |
| Wyoming | Articles $100; licence tax at least $60 | Asset-based |
| South Dakota | $150 online; $55 annual report | No corporate income tax |
| Texas | $300 | Margin tax; $2.65M no-tax-due threshold |
| Florida | $70; $150 annual report | Corporate income tax can still apply to some S corps |
These figures do not identify a lowest-tax state. Verify with official sources.
When an investor-focused state helps
Delaware may suit a planned financing round or later C corporation conversion. That advantage may not outweigh extra registrations if operations are elsewhere.
The Australian lens
Confirm whether each shareholder is a US citizen, resident alien or nonresident alien. Then weigh:
- US withholding and filing
- Australian residency and foreign income reporting
- Treaty relief and foreign income tax offsets
- Controlled foreign company rules
The 1982 treaty, as amended in 2001, is not blanket relief from state taxes. The ATO's offset guidance requires qualifying foreign tax and matching Australian income, and general guidance does not settle every S corporation or PTET outcome.
Take coordinated US and Australian advice.
From State Selection to Filing: A Practical S Corp Tax Action Plan
At formation or conversion
- Confirm entity and shareholder eligibility.
- Obtain an EIN (a responsible party without an SSN or ITIN may enter "foreign" on Form SS-4, line 7b).
- File Form 2553 on time.
- Check for a separate state S election.
- Register for state and local taxes.
- Decide whether foreign qualification is needed.
Annual checklist
- Form 1120-S and K-1s, due the 15th day of the third month after year-end; Form 7004 gives six months to file, not to pay
- State income or franchise returns
- PTET elections and estimated payments
- Nonresident withholding or composite returns
- Payroll, sales/use and property tax filings
- State annual reports (Delaware 1 March, Florida 1 May, Texas generally 15 May)
Where VJM Global fits
VJM Global supports Australian businesses with US entities through cross-border accounting, tax compliance coordination, financial records and deadline management, including multi-state income, sales and payroll filings. The firm serves 250+ Australian businesses and 500+ American business owners.
Keep a state-by-state compliance calendar and review it every tax year, especially after hiring remote staff, entering new markets, changing ownership, making a PTET election or relocating. Obtain a state-specific legal or tax opinion where required.
Frequently Asked Questions
What is the best state to have an S corp?
It depends on where you operate, who your shareholders are, your tax exposure, investor plans and compliance costs. Don't choose based only on the absence of individual income tax.
Do all states recognise a federal S corporation election?
Many states conform, but some require a separate election, tax the entity or do not fully recognise federal S treatment. New York needs Form CT-6, and New York City does not recognise S status. Check the state revenue department.
Do S corporations pay state income tax?
Shareholders usually pay state tax on passed-through income. Some states also tax the entity, and franchise, minimum, payroll, sales/use, property and local taxes may still apply.
Does incorporating in a state without individual income tax eliminate state tax for an S corp?
No. Obligations generally depend on nexus and activity. Operating, employing people, owning property or making taxable sales in another state can create obligations there.
What happens if an S corp operates in more than one state?
Expect foreign qualification, income allocation or apportionment, nonresident shareholder filings, withholding or composite returns and separate state compliance. Each state sets its own requirements.
Can an Australian resident own shares in a US S corporation?
A nonresident alien generally cannot be an S shareholder. US citizenship or US tax residency may change the analysis, so get coordinated US and Australian advice before electing.
