What’s a franchise tax?
Franchise Tax Definition: Some states charge franchise taxes to businesses that want to operate there. A privilege tax grants businesses the right to incorporate or use a form. Even if chartered in another state, some states may tax companies. Despite their name, franchise taxes are not taxes on franchises and are distinct from annual federal and state income taxes payable.
Understanding Franchise Taxes
Franchise taxes are state taxes on businesses that allow them to operate in a particular jurisdiction. In 2020, these states were Alabama, Arkansas, California, Delaware, Georgia, Illinois, Louisiana, Mississippi, New York, North Carolina, Oklahoma, Tennessee, and Texas. Kansas, Missouri, Pennsylvania, and West Virginia eliminated corporate franchise taxes.
Despite its name, a franchise tax is not a franchise tax. This fee applies to corporations, partnerships, and LLCs operating within the state. Franchise taxes do not apply to fraternal organizations, nonprofits, and certain LLCs. An expanded list of exemptions follows. Companies that use in multiple states usually pay franchise taxes in their home state.
Despite its name, a franchise tax is not a franchise tax.
Rates of Franchise Tax
Franchise taxes are not considered income taxes as they do not replace federal and state income taxes. They supplement income taxes. They are usually paid annually with other taxes. Franchise taxes vary significantly by state. Different states calculate franchise tax based on an entity’s assets or net worth, while others use capital stock value.
Other states may charge a flat fee or tax based on gross receipts or paid-in capital for all businesses operating in their jurisdiction.
Franchise taxes in Delaware
Delaware franchise tax rates range from $175 to $250,000 per year, depending on corporation size and filing method. LPs, LLCs, and general partnerships in Delaware only pay a $300.1 annual tax.
The California Franchise Tax Rate
California has layered small business taxes, including franchise taxes, in certain situations. Corporations and LLCs that elect to be corporations are exempt from the franchise tax. California franchise tax rates apply to S corporations, LLCs, LPs, and LLPs.
S corporations in California pay $800, or 1.5% of their net income, in franchise taxes. The franchise tax for LLCs is $800. Corporations pay California’s corporate income tax instead of a franchise tax, while LLPs and LPs pay the minimum $800 franchise tax.
A multi-state company may have to pay franchise taxes in all of its registered states.
Special Considerations
A multi-state company may have to pay franchise taxes in its registered states. Sole proprietorships are typically exempt from franchise taxes and other state business income taxes due to their lack of formal registration with the state. These entities are franchise tax-exempt:
- Except for single-member LLCs, sole proprietorships
- General partnerships with all-natural owners (except limited liability partnerships)
- Tax Code Chapter 171, Subchapter B: exempt entities
- Some passive, unincorporated entities
- Certain grantor trusts, natural person estates, and escrows
- Mortgage investment conduits (REMICs) and qualified REITs
- nonprofit self-insurance trust under Insurance Code Chapter 2212
- IRS 401(a)-qualified trust
- IRS Section 501(c)(9)-exempt trust
- unincorporated political committees
Franchise vs. Income Tax
There are critical differences between income tax and franchise. Franchise taxes, unlike state income taxes, do not consider a corporation’s profit. A business must file and pay franchise tax regardless of its annual profit. How much an organization pays in state income taxes depends on its annual revenue.
All corporations with income from state sources, regardless of their business location, are subject to income tax. Some states define doing business differently based on whether the company sells, has employees, or has a physical presence in the state.
Delaware is a popular tax shelter for corporations not based in the state. Instead, they pay a Delaware Department of State franchise tax.
Example of Franchise Tax
As mentioned, each state calculates franchise taxes differently. Let’s take Texas. The state’s comptroller taxes all businesses and mandates annual franchise tax reports by May 15. The state calculates franchise tax using a company’s margin in one of four ways:
- Total revenue x 70%
- Total revenue minus COGS
- Revenue minus all employee compensation
- All revenue minus $1 million
Corporations calculate revenue by subtracting statutory exclusions from their federal income tax return.
The Franchise Tax Board?
State-run franchise tax boards collect personal and business taxes.
Are the Franchise Tax Board and IRS the same?
The Franchise Tax Board operates like the IRS but at the state level. The California Franchise Tax Board aims to “help taxpayers file tax returns timely, accurately, and pay the correct amount to fund services important to Californians.”
Franchise Taxes Due When?
Franchise tax deadlines vary by state. Delaware franchise taxes are due on March 1.
What If You Don’t Pay Franchise Tax?
The Franchise Tax Board tracks and penalizes corporations for late franchise tax payments in different states. Non-payment or late payment in Delaware carries a $200 penalty and 1.5% monthly interest.
Bottom Line
Franchise taxes allow corporations to operate in a state, but tax rates vary by legal filing and gross income.
Conclusion
- Some states charge franchise taxes to businesses that want to operate. Despite its name, a franchise tax is not a franchise tax.
- Fraternal organizations, nonprofits, and some LLCs are franchise tax-exempt.
- Franchise taxes supplement federal and state income taxes.
- Franchise tax is not based on the organization’s profit and varies by state.
- Kansas, Missouri, Pennsylvania, and West Virginia eliminated corporate franchise taxes.
