Franchise Tax: What Business Owners Need to Know
A franchise tax is not a tax on franchises, like a McDonald’s or a 7-Eleven. Instead, it’s a tax paid by businesses for the privilege of doing business in certain states. Franchise taxes are separate from the income taxes and sales taxes a business might pay.
Read on to learn more about whether your small business might need to pay a franchise tax and the consequences you’ll face if you ignore your franchise tax obligations.
What is a franchise tax?
A franchise tax is a state tax imposed on businesses or for-profit corporations doing business in the state. Because the primary purpose of a franchise tax is to raise revenue for the state, a franchise tax is distinct from federal taxes, such as income or excise tax.
Common business entities that may be subject to franchise taxes include corporations and limited liability companies (LLCs). Franchise taxes can also apply to sole proprietorships and partnerships, depending on the state. States typically don’t impose franchise taxes on nonprofit or fraternal organizations.
Franchise taxes vary widely from state to state. There are three ways states may impose a franchise tax:
- Flat fee. Some states impose a flat fee. For example, in Delaware, foreign corporations operating in the state pay a flat fee of $125. LLCs, limited partnerships (LPs), and general partnerships registered to do business in the state pay a flat fee of $300. However, corporations in Delaware don’t pay a flat fee. Instead, their franchise tax is based on the number of authorized shares or total gross assets.
- Percentage of gross receipts. Some states base franchise taxes on a percentage of gross receipts. For example, Nevada’s “Commerce Tax” applies to any business with more than $4 million in Nevada-sourced gross revenue. The tax rate depends on the business’s North American Industry Classification System (NAICS) code.
- Based on net worth. Some states base franchise taxes on the business’s net worth. For example, Georgia levies a Net Worth Tax on all corporations operating in the state with a net worth greater than $100,000. The tax ranges from $125 for businesses with net worth between $100,000 and $150,000 to $5,000 for companies with a net worth greater than $22 million.
Several states in the United States, including Kansas, Missouri, Pennsylvania and West Virginia, do not impose any franchise tax on businesses at all. They have opted out of levying this type of tax and may fill the state’s coffers with revenues from other forms of taxation, such as state income or sales taxes.
Franchise tax vs. income tax
A franchise tax does not replace a state income tax. Unlike income taxes, which are based on a business’s profits or earnings, franchise taxes can be based solely on a business’s presence in the state. In other words, if a business is licensed to operate in the state, it may have to pay a franchise tax for the privilege of doing business in the state, regardless of whether it is profitable.
State variations with the franchise tax
Some states require businesses that wish to operate within their borders to pay both an income tax and a franchise tax. In other states, companies may only be obligated to pay one or the other.
- For example, Oregon has a corporate income tax, but in 2020, the state also started levying a gross receipts tax (known as a corporate activity tax in the state) on businesses with gross receipts over $1 million.
- On the other hand, there’s no state income tax in Nevada, but businesses with more than $4 million in gross revenue must pay the state’s Commerce Tax.
In states where businesses pay both income tax and franchise taxes, they may not necessarily pay them to the same entity. In some states, there is a designated state agency or department that collects franchise taxes, and it may be separate from the entity in charge of collecting income taxes.
Franchise tax example
Franchise taxes can be confusing to business owners, especially when the tax obligations vary from state to state. To help you understand how franchise taxes work in different states, here are a few examples of how businesses are taxed.
Delaware franchise tax example
Delaware does not have an income tax, but corporations, LLCs, and partnerships doing business in the state must pay a franchise tax. This franchise tax varies depending on the business structure and size.
LLCs and partnerships formed or registered in the state pay a flat annual franchise tax of $300. Foreign corporations — those incorporated outside of Delaware but doing business in the state — must pay an annual flat fee of $125.
Domestic corporations — those incorporated in Delaware — have three options for calculating their franchise tax.
- Non-Stock for Profit. All non-stock, for-profit corporations pay a minimum franchise tax of $175 annually.
- Authorized Shares method. Corporations with no par value stock pay a minimum franchise tax of $175 if they have 5,000 or fewer authorized shares. For corporations with 5,001 to 10,000 shares, the annual tax is $250. Each additional 10,000 shares (or portion thereof) beyond 10,000 increases the annual fee by $85, up to a maximum franchise tax of $200,000.
- Assumed Par Value Capital method. This method applies to corporations with par value stock. The franchise tax rate is $400 per million (or portion thereof) of assumed par value. You calculate the assumed par value by dividing the company’s gross assets by its total issued shares, including treasury stock.
California franchise tax example
In California, any business that offers limited liability for its owners is required to pay an annual franchise tax of $800 regardless of its profits or size. This includes LLCs, corporations, limited partnerships, and limited liability partnerships doing business or organized in California. Sole proprietorships and general partnerships aren’t subject to the franchise tax.
High-earning corporations in California may have to pay more. C Corporations pay either an income tax rate of 8.84% of their net income and the $800 franchise tax, whichever is greater. S corporations pay either 1.5% of their net income or the $800 minimum franchise tax, whichever is greater. The annual minimum franchise tax doesn’t apply in the company’s first year in business.
Frequently asked questions
In most cases, businesses are required to file separate franchise tax returns in each state where they do business. The due date for filing a franchise tax return depends on the state and may vary from year to year. Generally, it’s best to check with your state’s department of revenue, franchise tax board, or other tax authority to determine when your franchise tax return is due.
The Franchise Tax Board (FTB) is the California state agency responsible for collecting and administering taxes on individuals and businesses in the state. The FTB collects corporate income taxes, franchise taxes, personal income taxes, sales taxes, estate taxes and other types of taxes.
It is important to understand the consequences of not paying your franchise taxes if you are obligated to pay them in any state where you’re doing business.
First, many states levy substantial fines and interest on businesses that fail to pay their franchise taxes. In some cases, the penalties and interest can reach thousands of dollars.
In addition to financial penalties, failing to pay franchise taxes can lead to having your business license or permit revoked and could even result in criminal prosecution. For these reasons, it is important to be aware of your franchise tax obligations in every state where you do business and make sure that you make all franchise tax payments on time.