What Is a Franchise Tax?

The term "franchise tax" refers to a tax paid by certain enterprises that do business in some states.

Also called a privilege tax, it gives the business the right to be chartered and/or to operate within that state. Companies in some states may also be li🌠able for the tax even if they are chartered in another state.

Despite the name, a franchise tax is not a tax on 澳洲幸运5官方开奖结果体彩网:franchises and is seꦛparate from federal and state income taxes that must be filed annually.

Understanding Franchise Taxes

A franchise tax is a state tax levied on certain businesses for the right to exist as a legal entity a🤡nd to do business within a particular jurisdiction.

As of 2024, these states were:

• Alabama
• Arkansas
• California
• Delaware
• Georgia
• Illinois
• Louisiana
• Mississippi
• New York
• North Carolina
• Oklahoma
• Tennessee
• Texas

Kansas, Missouri, Pennsylvania, and West Virginia all discontinued their corporate franchise taxes.

Contrary to what the name implies, a franchise tax is not a tax imposed on a franchise. Rather, it's charged corporations, partnerships, and other entities such as a 澳洲幸运5官方开奖结果体彩网:limited liab⛦ility corporation (LLC) that do business within the boundaries of a state𝕴 that levies it.

Some entities are exempt from franchise taxes, namely 澳洲幸运5官方开奖结果体彩网:fraternal organizations, nonprofits, and certain LLCs. ꧒A more comꩲprehensive list of exemptions is noted below.

Companies that do business in multiple states may be subject to the tax in multiple states. At a minimum, they're charged a franchise tax in the state in which they are formally registered (if that state has one).

Franchise Tax Rates

Franchise taxes do not replace federal and state income taxes. They are paid in addition to them. They are usually paid annually at the sa🎃me time that other taxes are due.

The amount of franchise tax can differ greatly depending on the tax rules of each state. Some states calculate the amount of franchise tax owed based on an entity's assets or 澳洲幸运5官方开奖结果体彩网:net worth, while other states use the value of a company's 澳洲幸运5官方开奖结果体彩网:capital stock.

Still, other states may charge a flat fee to all businesses operating in their jurisdiction or calculate the tax rate on the company’s 澳洲幸运5官方开奖结果体彩网:gross receipts or 澳洲幸运5官方开奖结果体彩网:paid-in capital.

Delaware Franchise Tax Rates

Depending on the size of the corporation and how it decides to file, Delaware franchise tax rates range from between $175 to $250,000 annually. Meanwhile, 澳洲幸运5官方开奖结果体彩网:limited partnerships (LPs), LLCs, and 澳洲幸运5官方开奖结果体彩网:general partnerships formed in the State of Delaware are required to pay an annual tax of $300.

California Franchise Tax Rates

澳洲幸运5官方开奖结果体彩网:Small business taxes in California are layered, with a franchise tax applying in certain situations. For example, the franchise tax does not apply to corporations and LLCs that elect to be treated as corporations (they pay income tax instead).

However, California franchise tax rates do apply to S corporations, LLCs, LPs, and 🍬澳洲幸运5官方开奖结果体彩网:limited liabꦰility partnerships (LLPs).

The franchise tax rate for S corporations is the greater of either $800 or 1.5% of the corporation's net income. For LLCs, the franchise tax is $800. For LLPs and LPs, it varies but the minimum is $800.

Franchise Tax Exemptions

💃 Franchise tax exemptions provide relief from the obligation to pay franchise taxes. One🍨 common exemption criterion is business size, with many jurisdictions offering exemptions or reduced tax rates for small businesses.

Based on Financial or Workforce

These exemptions may be determined by factors such as annual revenue, total assets, or number of employees. They aim to alleviate the tax burden on startups and smaller enterprises to foster entrepreneurship and economic growth.

Based on Structure or Purpose

Certa🅰in types of businesses or൲ entities may qualify for specific franchise tax exemptions based on their organizational structure or purpose as well.

Nonprofit organizations are often exempt from franchise taxes as they operate for char📖itable, educational, or rel🐼igious purposes and are not for-profit entities.

Similarly, governmental entities and certain types of cooperatives may also be eligible for exemptions from franchise taxes. As an incentive for offering services that benefit society, taxing authorities may offer a financial incentive via a tax exemption. 

Based on Societal Benefits Offered

Additionally, jurisdictions may offer franchise tax exemptions for businesses engaged in particular industries or activities deemed beneficial to the economy or society. Note tha꧂t this extends beyond the types🍌 of companies talked about in the section above.

For example, these exemptions are often designed to motivate investment in specific sectors such as 澳洲幸运5官方开奖结果体彩网:renewable energy, manufacturing, or research and development.

Governments aim to stim꧅ulate innovation, job creation, and overall economic development, so they may be willing to offer financial benefits in exchange for a focus in these areas. 

Consequences of Not Paying Franchise Taxes

Financial Fallout

The consequences of not paying franchise taxes can be significant for businesses. Governing authorities often impose financial penalties which can accrue over time as long as taxes remain unpaid. 

Failure to pay franchise taxes can damage a business' credit rating and reputation, making it more challenging to secure financing or conduct business transactions in the future.

As the company attempts to work with others and has to undergo credit checks, pending franchise taxes may disrupt its ability to secure credit lines or financing alternatives.

Legal Repercussions

In addition to financial penalties, busine🦋sses that fail to pay franchise taxes may face legal consequences, including the possibility of having their business licenses revoked or suspended.

Many jurisdictions require businesses to be in good standing regarding their tax obligations to maintain their legal authority to operate. Therefore, not paying franchise taxes could jeopardize this authority.

Tax Liens

Persistent non-compliance with franchise tax obligatioꦐns can escalate the severity ofꦺ consequences, eventually leading to more drastic measures such as tax liens or levies.

Tax liens give taxing authorities a legal claim on a business's assets as collateral for unpaid taxes, potentially resulting in the seizure or sale of property to satisfy the tax debt.

For example, the government may place a lien on company assets. The government may then sell those assets to raise money that is used ﷽in part to pay off the franchise taxes.

While this means the franchise taxes (and accrued penalties) are now paid, it also means the business could be disrupted. For example, consider if the only company car was seized and sold during this process.

Franchise Taxes and Tax Planning Strategies

Manage Factors Affecting Net Worth or Capital

Businesse✱s can strategically manage their taxable assets and liabilities to reduce their franchise tax burden.

This can involve careful considerati꧑on of🐽 factors such as asset valuation methods, inventory management practices, and debt financing arrangements.

The goal here is to be mindful of what items account for the company’s taxable net worth or capital base. By minimizing this, the company can save on franchise taxes. 

Leverage Deductions and Credits

Businesses may ♛also be able to get deductions, credits, and ex𒁏emptions that lower their franchise tax amount. This can include leveraging deductions for business expenses such as rent, utilities, salaries, and supplies.

Companies may also be able to get credits for the economic activity items mentioned above. Since the government may want companies to do these activities, there may be relevant credits related to, e.g., research and development, job creation, or environmental conservation. 

Special Considerations

澳洲幸运5官方开奖结果体彩网:Sole proprietorships are not usually subject to franchise taxes and other forms of state business income tax, in part because they are not formally registered with the 𒉰state in which they do business.

In addition, certain types of organizations may be exempted from the franchise tax outrig🦋ht. For example, Texas lists many such ♒organizations. Some of these are:

• Cemetery corporations
• Residential Homeowners' Associations
• Religious organizations
• Credit Unions
• Recycling operations
• Non-Profit water supply corporations
• Cooperative housing corporations
• Corporations organized for conservation purposes

Franchise Tax vs. Income Tax

There are some key differences between a franchise and income tax. Unlike state income taxes, franchise taxes are not based on a corporation’s profit. A business entity must file 🅘and pay the franchise tax regardless of whether it makes a profit in any giv♔en year.

On the other hand, 澳洲幸运5官方开奖结果体彩网:state income taxes—and the amounts paid—relat🦩e directly to how 🐎much an organization makes during the year.

Income tax is also applied to all 澳洲幸运5官方开奖结果体彩网:corporations that derive income from💃 sources within the state, even though they may not do business within its boundaries.

Some states may define "doing business" differently because each may focus on different factors. These may include whether the company sells in the state, has employees in the state, or has an actual physical presence in the state.

Delaware is 澳洲幸运5官方开奖结果体彩网:well-known as a tax shelter, especially for corporations that do not conduct business in the state. So, such businesses have to pay a franchise tax administered by the Delaware Department of State.

Example of a Franchise Tax

As noted above, each state may have a different method of calculating franchise taxes. Let's use Texas as an example.

The state's 澳洲幸运5官方开奖结果体彩网:comptroller levies taxes on all entities that do business in the state and require✅s them to file an Annual Franchise Tax Report every year by May 15th.🎶

The state calculates its franchise tax based on a company’s margin which is computed in one of four ways:

• Total revenue multiplied by 70%
• Total revenue minus 澳洲幸运5官方开奖结果体彩网:cost of goods sold (COGS)
• Total revenue minus compensation paid to all personnel
• Total revenue minus $1 million

Corporate revenue is calculated by subtracting statutory exclusions from the amount of revenue reported on a corporation's federal income 澳洲幸运5官方开奖结果体彩网:tax return.

The Bottom Line

Franchise taxes paid by a company give it the right to do business in a state. States have varying tax rates based on different benchmarks, such as a business' legal structure, how it elects to file, or gross income.