Franchise taxes are taxes that a business, usually a corporation, must pay to conduct business in the state. The franchise tax is distinct from income or profit tax, which businesses must pay.
Franchise taxes are what states charge businesses for the “privilege” of doing business in their state.
The franchise tax is a tax that states charge on corporations and other business entities, such as limited liability companies (“LLCs”), for the privilege of incorporating or doing business in their state. These taxes are distinct from and owed in addition to state income taxes that most states levy on corporations and other companies.
Most, but not all, states levy franchise taxes. Specific businesses are fully or partially exempt from the tax in some states. This may include nonprofit corporations, fraternal organizations, and some LLCs. Some states also exempt smaller businesses from the tax.
Franchise tax rates differ widely from state to state. While some states have a single flat-rate franchise tax, others have a graduated rate based on the scope of the business or its net income. Some states alter the tax rate based on the business entity or company involved.
Franchise taxes must ordinarily be paid yearly, often at tax time when other state taxes are paid.
A corporation or other business entity invariably has to pay the franchise tax in its home state. It may also have to pay franchise taxes in other states where it does business or owns property. Many businesses and other entities have to pay franchise taxes in multiple states.
If a business fails to pay a state’s franchise tax, the business will lose the legal privilege to do business in the state, meaning it won’t be able to file lawsuits in the state or enforce its contracts there. It may also be subject to penalties and fines.
When you create a corporation or other business entity, be certain to learn about the franchise tax provisions in your home state and any other states in which you intend to conduct business or own property. Each state has an agency or department within a larger agency responsible for collecting franchise taxes. This may be the state controller’s office, state taxation department, or something else. For instance, this taxing agency is called the Franchise Tax Board in California.
How Much Does My Business Have to Pay in Franchise Taxes?
Tax rules differ from state to state, and the franchise tax amount a company owes hinges on the type of business. Nonprofit organizations are usually exempt from franchise taxes if exempt from federal income taxes.
Elements that affect the amount of franchise tax owed include:
- Gross assets of the business
- Number of authorized shares of corporation
- The value of property owned by the business
What Is the Nexus Test?
Whether or not a company must pay a franchise tax to a state where it does business can cause some puzzlement. Some states report using both the economic and physical presence tests, and in some states, there are no written, public interpretations of their test.
What Is the Physical Presence Test?
The physical presence test is based on Quill Corp. v. North Dakota, a United States Supreme Court decree regarding use tax.
Some states use the Quill physical presence test to determine whether or not a company must pay a franchise tax. Delaware, Hawaii, Massachusetts, Pennsylvania, and Texas report using the physical presence test.
What Is the Economic Presence Test?
Many states use an “economic presence” test to decide whether a business will be subject to state sales or franchise tax. This test implies that States have the right to tax or “nexus” exclusively because a business has sales or otherwise emanates an economic benefit from activities within their borders.
What Is the Relationship to Corporate Tax?
States with higher corporate income taxes usually maintain low or no franchise taxes.
How Is Delaware Different?
Delaware has a substantial franchise tax. Other states have either minor taxes or none at all.
Who Has to Pay Franchise Taxes?
Usually, businesses mandated to register with the state are also instructed to pay a franchise tax. Businesses owned and run by one person, or sole proprietors, aren’t subject to franchise tax in some states where they aren’t directed to register the business with the state.
To find out whether or not you need to register your business with the state, you can check with the United States Small Business Administration. Reporting with the state makes your business a distinguishable legal entity, which isn’t required for all small businesses.
To determine whether you need to register your business, you need to have the location and the business structure bound and evident.
Which States Have Franchise Taxes?
Only some states have businesses pay some franchise tax. These taxes can be assessed in addition to the other state’s taxes. Some states with a type of franchise tax include Alabama, Arkansas, California, Delaware, Georgia, Illinois, Louisiana, Mississippi, New York, North Carolina, Oklahoma, Tennessee, and Texas. Washington D.C. also has a franchise tax.
Where Have Franchise Taxes Been Stopped?
The business franchise tax in West Virginia was eliminated in 2015 and in Kansas in 2011. It’s also been stopped in Missouri and Pennsylvania.
A franchise tax differs from a company’s standard income tax when filing taxes each year. The IRS has a useful website that displays income tax details for different business structures like partnerships and limited liability companies, or LLCs, on a federal level.
How Much Is a Franchise Tax, and How Can I Calculate it?
The rate for franchise taxes differs from state to state, just like the other rules around the tax due. Laws around these taxes differ based on the location of and the kind of company you operate and own, which is why it’s so essential to be mindful of the specifics of the franchise tax in your state.
The franchise tax is a flat rate in some states, making it easy to calculate depending on your type of business. Elsewhere though, the tax is calculated in several ways.
Metrics that can be used to determine the tax include:
- The percentage of the business’s assets.
- A percentage of the business’s net worth.
- Even the gross receipts of the business for the tax year.
Most states, like Delaware, have calculators or particulars on how to estimate the specific tax on their websites. Each state computes the tax differently, so it’s soundest to double-check before filing. Some states, like New York, demand business owners compute their tax several ways and then pay the highest calculation.
Who Collects the Franchise Tax?
This, too, differs from state to state. Depending on where you’re paying the franchise tax, various departments within the state government are accountable for collecting the tax.
In Texas, where the franchise tax is defined as “a privilege tax imposed on each taxable entity formed or organized in Texas or doing business in Texas,” the Comptroller’s Office oversees the tax collection. In California, on the other hand, there’s a specified Franchise Tax Board liable for composing the tax.
How Can a Lawyer Help?
Taxation is a highly complex area of the law, and a tax attorney can help you manage your business assets in a way that reduces your tax liability. An attorney can also assist you with your personal income taxes.