State taxes for startups: What founders miss most often

As a founder, you probably have federal taxes on your mind. You file a return, work with an accountant, and move on. State taxes, though, might fall outside your radar — until a notice shows up from a state you didn't think you owed anything to.

It's not a matter of being careless. State tax rules are fragmented and vary wildly from state to state. If you have remote employees, customers in multiple states, or a Delaware C-corp with operations elsewhere, you're more exposed than you might realize. And the penalties for missed filings can add up fast — even when you don't owe any actual tax.

You don't need to become a state tax expert. But to avoid problems down the road, you do need to know what to watch for.

Federal taxes can be relatively straightforward for early-stage startups. You have one entity, one return, and one set of rules to follow. The IRS cares about your total income, regardless of where you earned it.

State taxes work differently. Each state sets its own rules for what triggers a filing obligation, what gets taxed, and at what rate. You can owe taxes (or at least, owe a filing) in states where you've never set foot. There's no single system governing all of it, which is why founders who feel confident about their federal situation can still get blindsided at the state level.

Here’s how to think about it: Federal taxes follow your entity. State taxes follow your activity: where your employees sit, where your customers are, and where your revenue comes from. That distinction is what trips most founders up.

Business taxes by state vary in unintuitive ways. A founder with employees in three states and customers in ten may have filing obligations in most of them.

There are several types of state business tax obligations and ways that your company may be caught off guard.

State income tax

Not every state levies an income tax, but for those that do, "no revenue" doesn't always mean "no filing." Some states require you to file a return even when your taxable income is zero. Skipping that filing can trigger penalties and flag your company with the state’s systems.

Franchise tax and gross receipts tax 

Delaware's franchise tax is one of the most common surprises for startup founders. You may have incorporated in Delaware for its legal advantages, but the state still expects an annual franchise tax — and the bill can be large. 

California charges an $800 minimum franchise tax even if your company is pre-revenue. Texas has a gross receipts tax (called the "margin tax"), and it doesn’t matter whether your company is profitable.

State-based franchise taxes and gross receipts taxes aren't based on income in the traditional sense; they're tied to your entity's existence or gross revenue. That means these taxes can apply long before your company is profitable.

Payroll and withholding tax

One remote hire in a new state creates a new payroll tax obligation. You’ll likely owe withholding and unemployment taxes there, even if your company is headquartered somewhere else. 

For startups with distributed teams, these obligations add up quickly and add complexity to your payroll processing. 

Sales tax (and the SaaS gray area)

Sales tax on physical products is relatively straightforward. It’s much different for SaaS companies. Taxability of software-as-a-service varies by state, and some states are still figuring out how to classify digital services. SaaS companies often don't realize that they have sales tax collection obligations in states where their customers are located.

There's a reason certain states can come after you for taxes and others can't. It comes down to nexus — the legal threshold that determines whether a state can require you to file or pay. 

Nexus comes in two forms:

1. Physical nexus: This is the traditional standard: having an employee, office, or inventory in a state. For example, having one remote engineer in Colorado creates a nexus in Colorado. A warehouse in New Jersey creates a nexus in New Jersey.
2. Economic nexus: This is a newer and broader type of nexus. If your company crosses a certain revenue or transaction threshold in a state — even without any physical presence there — you may owe sales tax or other filings. 

Economic nexus is the outcome of the 2018 Supreme Court decision, South Dakota v. Wayfair. The case originally applied to sales tax but has since influenced how states think about other tax obligations.

For example, here's what this could look like in practice: Imagine a Delaware C-corp with founders in New York; remote engineers in Texas, California, and North Carolina; and customers across 30 states. That company likely has filing obligations in far more states than the founders realize — potentially in every state where it has employees and in states where it has crossed economic nexus thresholds.

Remote work and digital sales have made nexus nearly unavoidable for multi-state startups.

It's natural to look at state business income tax rates when you’re deciding where to incorporate or operate. But, for early-stage companies, the rate itself is rarely what causes problems. Many startups aren't generating enough taxable income for rate differences to matter much.

What actually costs founders money early on is everything related to state tax filing, such as filing fees, minimum taxes (like California's $800 franchise tax), and the compliance cost of preparing multi-state returns. Add penalties for late or missed filings, and the cost increases even more. A $0 tax bill in a state that requires a filing still generates a penalty if you don't file.

Although you may still choose to incorporate in a state based on its tax rate, you also need to understand all states where you have to file and make sure you actually do it.

A few assumptions come up again and again. Each one sounds reasonable, and each one leads to missed state tax obligations. 

These misconceptions can lead to tax surprises:

• Where you need to file: Though it might feel intuitive to file only in the state where your business is incorporated, operating activity in other states actually creates tax obligations across state lines. 
• How to handle pre-revenue: If your business is pre-revenue that doesn’t mean you don’t need to file taxes. Several states require filings and charge minimum taxes, regardless of your company’s revenue level. 
• Whether your accountant will handle state taxes: Many accountants focus on federal returns and may not proactively flag multi-state obligations.
• Having no physical office: Just because your company is all remote doesn’t mean you don’t have any state tax obligations. Having remote employees and economic nexus thresholds can trigger state-filing requirements.
• Sales tax and digital services: Sales tax doesn’t only apply to physical products. SaaS and digital services are taxable in a growing number of states, and the rules vary widely.

You don't need to master state tax law all by yourself, but you do need to track the right state business tax information. It’s also important to involve the right people early.

Hire a CPA with multi-state experience 

A general bookkeeper or tax preparer may not catch nexus triggers. As you look to partner with the right expert, ask specifically about state filing obligations, rather than waiting for your accountant to bring it up.

Track the basics internally

Three data points drive most state tax obligations: 

1. Where your employees live and work
2. Where your customers are (by state)
3. Where your revenue originates

If you can pull this information quickly, you're in good shape.

Keep your financial systems clean 

The harder it is to pull state-level revenue or payroll data, the more expensive and error-prone compliance becomes. Clean books make state taxes manageable. 

On their own, state taxes aren't inherently complicated. It’s the fragmentation across 50 states’ individual tax laws that adds complexity. Once you understand the general rules of thumb (activity creates nexus, nexus creates obligations), you at least know the scope of where you may need to file a state return.

The founders who avoid surprises are the ones who ask the right questions early and track the right data.