You asked what the state tax ramifications are for a business changing its structure from a sole proprietorship to a limited liability company (LLC) or a corporation.

As you know, the Office of Legislative Research is not authorized to give legal or tax opinions and this report should not be considered one.

This report briefly describes the state taxes applicable to businesses according to their structure. It does not cover taxes payable by all businesses based on their activities, location, or employees, such as sales and use taxes, property taxes, income tax withholding, or unemployment compensation taxes.

SUMMARY

The main difference between a sole proprietorship and an LLC or corporation from a state tax point of view is that LLCs and corporations are taxpayers in their own right, as entities separate from their owners. The owner of a sole proprietorship is liable for state personal income taxes on the income he derives from the business, but the business itself does not have to pay taxes on its income or because of its structure. On the other hand, an LLC must pay the annual business entity tax and a corporation is liable for the state corporation business tax.

A business that changes its structure must notify the Department of Revenue Services of the change, and if the business has to obtain a new Federal Employer Identification Number because of the change, it must also get a new Connecticut tax registration number.

BUSINESS ENTITY TAX

The state imposes an annual tax on foreign and domestic LLCs, limited liability partnerships (LLPs), limited partnerships (LPs), and S corporations that are required to file annual reports with the secretary of the state. The business entity tax is $ 250 per year. For the 2003 tax year, a 20% surcharge applies, making the tax $ 300 for that year.

The business entity tax is due every year on or before the 15^th day of the fourth month after the close of the taxable year the business uses for federal income tax purposes. If a business does not pay the tax within 30 days after it is due, it must pay interest of 1% per month or fraction of a month, starting from the due date, and a $ 50 penalty.

CORPORATION TAX

Any corporation that does business in Connecticut must pay the state corporation business tax. A corporation must calculate its tax liability in two ways. One method uses the company’s net income and the other its so-called “capital base” (outstanding stock, profits, and reserves). The net income calculation uses the company’s federal taxable income as its starting point and therefore incorporates most federal income definitions, deductions, rules, and exclusions.

Connecticut’s corporation tax is 7. 5% of net income or 3. 1 mills per dollar of capital base, whichever produces the larger tax, but no less than $ 250. A company can reduce the amount it has to pay by subtracting any corporation tax credits for which it may be eligible (see attached list). But the reduction for credits is limited to 70% of its total liability and, in any event, every company must pay the minimum tax of $ 250.

A 20% corporation tax surcharge applies to all corporations for the 2003 tax year. For the 2004 tax year, there is a 25% surcharge on any corporation with a 2004 tax liability greater than the $ 250 minimum tax. Surcharges must be calculated based on tax liability before applying any credits.

Corporations that do business in other states as well as Connecticut pay taxes only on the share of their net income or capital base attributable to Connecticut. This share is determined by apportionment formulas specified in Connecticut law that compare a company’s Connecticut activity with its overall operations. For most corporations, apportionment is based on three factors: sales, payroll, and property, with a double weight in the formula given to sales. For financial services companies, manufacturers, and broadcasters, apportionment is determined solely by sales, that is, their sales in Connecticut as a proportion of their national sales.

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