Federal vs. State Tax Filing: The 2025 Small Business Owner’s Guide 

Tax season is a huge challenge when you run a small business.”

You’ve got forms coming in from every direction, deadlines popping out of nowhere, and rules that seem to shift just when you finally understand them.

And the part that confuses most business owners the most? The difference between federal and state taxes.

If you’ve ever assumed, “Well, if I filed my federal return, my state return must be similar,” you’re definitely not alone.

Unfortunately, that's one of the biggest misconceptions small business owners run into. Federal rules don’t always match state rules. A deduction you can claim federally might be rejected by your state.

The income your business reports federally might be calculated differently at the state level.

Even filing deadlines and required forms can vary widely.

And because 2025 brings updates to federal forms, changes in nexus rules, and new digital income reporting requirements, keeping up can feel like a full-time job.

In this guide, you’ll clearly understand how federal and state taxes differ, which rules apply to you, and how to avoid the mistakes that cause penalties, interest, or stress.

Understanding the Basics: Federal vs. State Taxes

Why the U.S. Has Both Federal and State Tax Systems

Federal taxes help fund national programs—Social Security, Medicare, national defense, federal infrastructure, and government operations.

State taxes cover localized services such as schools, police, roads, state-level programs, and public services.

Because the federal government and each state operate independently, they each create separate tax rules. This is why you file two returns: one to the IRS and one to your state (unless you live somewhere with no income tax).

What Federal Taxes Cover

Federal taxes include:

• Income tax
• Payroll taxes (Social Security and Medicare)
• FUTA (federal unemployment)
• Excise taxes
• Certain business credits and incentives

These apply no matter where your business is located.

What State Taxes Cover

States have their own mix of taxes, which might include:

• State income tax
• Sales and use tax
• Franchise tax
• Gross receipts tax
• Property tax
• Industry-specific excise taxes

Your state may use some, all, or unique variations of these.

Why Small Business Owners Must Understand Both

The biggest reason? States don’t always “conform” to federal rules.

Some follow federal guidelines closely. Others adjust them or reject them entirely.

So,your business might owe tax at the state level even if it owes nothing federally—or vice versa.

Federal Tax Filing for Small Businesses in 2025

Federal Filing Requirements by Business Structure

Your structure determines how you file:

• Sole proprietorship: You file Schedule C with your Form 1040.
• Partnership: File Form 1065; income flows to partners.
• S Corp: You file Form 1120-S and issue K-1s to shareholders.
• C Corp: You file Form 1120 and pay corporate income tax.
• LLC: You’re taxed based on how the LLC is classified (default or elected).

Key Federal Forms Small Business Owners Must Know

You’ll see forms like:

• Schedule C
• Form 1120
• Form 1120-S
• Form 1065
• Forms 941, 940, W-2, and W-3

Federal Credits and Deductions Available in 2025

Common opportunities include:

• 20% QBI deduction (for eligible pass-throughs)
• Section 179 expensing
• Bonus depreciation (gradually phasing down)
• Energy-efficient equipment credits
• Hiring and training incentives

Each credit has very specific eligibility rules, so always double-check the details.

State Tax Filing for Small Businesses in 2025

Unlike the IRS, there is no standardized state tax system. Every state sets its own:

• Tax rates
• Filing deadlines
• Industry rules
• Nexus thresholds
• Definitions of taxable income

This means two states can tax the same business activity differently.

Types of State Taxes Most Small Businesses Encounter

You may encounter:

• State income tax
• Sales and use tax (common for product sellers and many services)
• Franchise or privilege tax (charged for doing business in a state)
• Gross receipts tax (tax on revenue, not profit)
• Property tax on business assets

States With No Income Tax—But Other Hidden Taxes

States like:

• Texas
• Florida
• Washington
• Tennessee
• Wyoming

don’t have state income tax—but they do have franchise taxes, gross receipts taxes, or heavy sales tax systems. So “no income tax” doesn’t mean “no state tax.”

Federal vs. State Tax Differences Small Business Owners Must Understand

Understanding the difference between federal and state tax rules can save you money and prevent headaches you definitely don’t need.

Even though both systems tax your business, they do it in completely different ways.

This section helps you understand where those differences show up and how they affect the way you operate, plan, and file.

1. Filing Requirements

Federal filing requirements are mostly straightforward. You file your return once a year, and your deadlines depend on your entity type.

The IRS tells you exactly which forms apply to your structure, and once you get comfortable with the process, it becomes fairly predictable.

State filing requirements? Not so predictable.

Every state can—and does—set its own rules. That means you might need to file:

• A state income tax return
• A franchise tax return
• A gross receipts tax return
• Multiple 4sales tax returns
• A city or local tax return
• A special industry tax return
• Separate estimated tax forms
• Additional informational statements

Some states require annual reports or minimum franchise taxes even if your business makes zero profit. Others charge flat fees just for being registered in the state. A few states require monthly sales tax filings even when your sales are small.

The tricky part? Your federal return might say one thing, but your state can require completely different information.

So even if you’re confident about your federal return, you still need to check your state’s specific requirements, because filing only the federal side doesn’t mean your state obligations are covered.

2. Taxable Income Definitions

You’d think “taxable income” would mean the same thing everywhere. Unfortunately, it does not.

Your federal taxable income acts as a starting point. From there, states make their own adjustments. Some “add back” deductions the IRS allows. Others “subtract” income from the IRS taxes.

Here’s what this looks like in real life:

• Your state may NOT allow bonus depreciation even though the IRS does.
• Your state may tax forgiven loans that the IRS excludes.
• Your state may require add-backs for federal R&D credits.
• Your state may have its own depreciation table that differs from federal rules.
• Your state may tax passive income differently from the IRS does.

This is why your federal taxable income almost never matches your state taxable income. When your state adjusts these numbers, your business might owe more—or less—than you expected.

3. Deductions and Credits

Deductions and credits are where most small business owners accidentally misfile.

At the federal level, deductions are governed by clear IRS guidelines. But states pick and choose which deductions they want to accept.

Common examples of deductions states treat differently:

• Section 179 expensing
• Bonus depreciation
• Net operating losses
• Retirement contributions
• Health insurance deductions
• Energy-related deductions
• Business meal deductions
• Federal QBI deduction (some states disallow or adjust it)

Credits get even more complicated. A credit that reduces your tax bill at the federal level might not exist at all in your state. Meanwhile, your state might offer credits that don’t exist on your federal return.

If you assume federal rules automatically carry over, you’re almost guaranteed to file incorrectly. And the state will catch it.

4. Entity-Level Taxes

Federal taxation depends almost entirely on your entity type—sole proprietorship, partnership, LLC, S corp, or C corp.

States take a very different approach.

Some states treat LLCs as pass-throughs (just like the IRS). Others treat them as corporations. Others charge a minimum annual tax regardless of income. Some states calculate tax based on revenue rather than profit. The variations are endless.

Here’s a quick comparison:

Federal level:

• S corps don’t pay income tax at the entity level
• Partnerships don’t pay income tax
• LLCs follow their federal election
• C corps pay a flat corporate tax

State level: You might face…

• Entity-level taxes
• Franchise taxes
• Margin taxes
• Gross receipts taxes
• Net worth taxes
• Alternative minimum business taxes
• Filing fees even when income = $0

A single-member LLC might owe nothing federally but still owe hundreds—or thousands—at the state level

5. Nexus Rules (Physical vs. Economic)

“Nexus” is the magic word that determines whether a state can tax your business. The moment your business has nexus in a state, you may owe:

• Income tax
• Sales tax
• Payroll tax
• Franchise tax
• Minimum business tax

And nexus rules have become MUCH stricter since the Wayfair Supreme Court ruling.

You create a physical nexus when you have:

• An employee in a state
• A contractor working for you
• A physical office or store
• A warehouse or storage
• Inventory stored in a fulfillment center (like Amazon FBA)

You create an economic nexus when you exceed a state’s revenue or transaction threshold—often as low as:

• $100,000 in sales
• 200 transactions
• Sometimes lower for certain industries

Because 2025 continues the trend of strict enforcement, it’s easier than ever to trigger nexus without realizing it

Filing in Multiple States: What You Need to Know

If your business serves customers in multiple states, hires remote employees, or sells online, you might owe taxes in more than one state, even if you don’t physically set foot there.

Multi-state tax rules are becoming more common every year, especially with remote work and online commerce booming.

Here’s how to navigate it without losing your mind.

When You’re Considered to Have Nexus

Nexus is the trigger that gives a state the right to tax you. And thanks to modern laws, it’s easier than ever to create a nexus unintentionally.

You create a physical nexus if you have:

• A remote employee working out of their home
• A contractor consistently providing services in that state
• A warehouse, storage unit, or rented office
• Inventory in a fulfillment center (Amazon FBA is the big one)
• A physical presence through trade shows or pop-up shops

You create an economic nexus when your business earns a certain amount of revenue in a state, often around $100,000 in sales. Some states use lower thresholds or include transaction counts.

This means you could owe tax in a state even if:

• You’ve never visited
• You never shipped anything directly
• You only sell digital products
• You use third-party fulfillment centers

Understanding where you have nexus is the first step in avoiding penalties.

Income Allocation and Apportionment

Once you have nexus in multiple states, you need to figure out how much income each state gets to tax.

States use formulas called apportionment formulas, which typically consider:

• Sales (most common factor)
• Payroll
• Property

Many states now use single-sales-factor apportionment, which bases tax only on where your customers are. That means if you’re located in one state but 80% of your customers live in another, that other state can claim most of your taxable income.

A simple example:

• You make $400,000 in revenue.
• 50% comes from customers in State A.
• 50% comes from customers in State B.

Even if your business never physically touches State B, you may owe half your income tax there due to economic nexus and sales apportionment.

This is one of the biggest reasons multi-state taxation can surprise business owners.

Multi-State Payroll Rules

Payroll becomes complicated when employees work:

• Remotely from different states
• Temporarily in another state
• In multiple states throughout the year
• Across state lines in daily operations

Most states require withholding tax based on where the employee actually works, not where your company is based.

This means you must:

• Register for payroll accounts in the employee’s state
• Withhold the correct state taxes
• File unemployment forms in that state
• Report wages to that state’s revenue department

If you fail to register properly, states can issue fines—sometimes steep ones.

Sales Tax in Multiple StatesSales tax is often the biggest compliance burden for multi-state sellers, especially online businesses.

You may need to:

• Register for sales tax permits
• File monthly or quarterly sales tax returns
• Collect sales tax from customers in certain states
• Remit those taxes to the individual states
• Track varying tax rates (which change often)
• Follow marketplace facilitator laws (Amazon, Etsy, eBay)

Marketplace facilitators handle sales tax collection for you—but only for marketplace sales. Anything sold on your website is your responsibility.

Many business owners accidentally assume Amazon covers all their sales tax. It doesn’t.

States also vary on whether they tax:

• Digital goods
• SaaS subscriptions
• Consulting services
• Professional services
• Mixed products and services

The rules shift constantly, and staying compliant requires keeping track of multiple states’ laws.

When You Need a CPA (and Why It Saves Money)

You’re juggling enough as a business owner. Once you deal with multi-state sales, employees in different states, complex entity structures, or varying deduction rules, tax software alone isn’t enough.

A CPA protects you from:

• Misfiling in high-penalty states
• Overpaying because you don’t know state-level deductions
• Underpaying because you misunderstand the nexus
• Missing entity-level fees or franchise tax obligations
• Incorrect payroll withholding

A great CPA doesn’t just file your taxes; they help you avoid costly mistakes before they happen.

Conclusion

Federal and state taxes may look similar at first glance, but once you dig into the details, the differences are huge.

Understanding how each system works and how they interact helps you avoid penalties, save money, and stay ahead of ever-changing rules.

With all the multi-state requirements, new 2025 updates, and shifting tax laws, having expert guidance can make all the difference.

That’s where Virtue CPAs shines.

Our team understands the complexities that come with running a business in today’s environment, and they help you navigate everything from federal filings to multi-state compliance, nexus evaluation, sales tax rules, and year-round planning.

Ready to simplify your tax life?

Contact Virtue CPAs today for a personalized consultation and expert guidance tailored to your business.