What is a franchise tax?
A franchise tax (also called a “privilege tax”) is a state-level tax charged to certain business entities for the right to be chartered in—or to do business within—a state. Despite its name, it’s not a tax on franchised businesses specifically; corporations, partnerships, LLCs and other legal entities can be subject to it. Franchise taxes are separate from federal and state income taxes and are typically payable annually.
Key distinctions
– Franchise tax vs. income tax: Franchise tax is for the privilege of doing business in a jurisdiction; income tax is levied on profits. Both can apply simultaneously.
– Not universal: Only some states levy a franchise tax; the rules, bases and rates vary widely by state.
(Source: Investopedia)
Which states have changed franchise-tax rules recently?
As of 2024, several states—Kansas, Missouri, Pennsylvania and West Virginia—had discontinued corporate franchise taxes. Always check current state law because legislation frequently changes.
Common ways states calculate franchise tax
States differ in how they measure the tax liability:
– Based on net worth, assets or capital stock (common)
– Based on paid-in capital or value of shares
– A flat or minimum fee for every entity in the state
– Based on gross receipts in some jurisdictions
Examples (illustrative, from Investopedia)
– Delaware: For corporations, franchise tax amounts vary significantly depending on filing method and size—ranging from roughly $175 up to $250,000 annually. LPs, LLCs and general partnerships formed in Delaware typically pay an annual tax of $300.
– California: Franchise taxes apply to S corporations, LLCs, LPs and LLPs in different ways. S corporations pay the greater of $800 or 1.5% of net income. LLCs pay a minimum franchise tax of $800. (These are state-specific rules; some corporations and LLCs electing corporate tax treatment are taxed differently.)
Who is commonly exempt?
Exemptions vary by state but often include:
– Nonprofit and certain fraternal organizations
– Some small businesses (based on revenue, assets or employee count)
– Certain governmental entities, cooperatives, or entities engaged in targeted public-benefit activities (e.g., renewables, R&D) under incentive programs
Consequences of not paying franchise taxes
– Financial fallout: penalties and interest that accumulate over time.
– Legal repercussions: suspension or forfeiture of a company’s right to do business; administrative dissolution.
– Tax liens: government may place liens on assets and potentially seize and sell assets to satisfy debts.
– Credit and reputation damage: unpaid obligations can harm the company’s ability to get financing and maintain supplier/customer relationships.
(Source: Investopedia)
Franchise Tax Board — what is it and how is it different from the IRS?
– Franchise Tax Board (FTB) is the California state agency that administers CA personal income and corporation/franchise taxes.
– The IRS is the federal tax authority. States’ tax agencies (like the FTB) are separate and administer state taxes. A business may owe both federal (IRS) taxes and state franchise taxes (FTB or comparable state agencies).
(Source: Investopedia)
When are franchise taxes due?
– Due dates vary by state and by entity type. Franchise taxes are typically paid annually and often follow the state’s filing schedule for corporate returns. States may also require estimated or quarterly payments in certain circumstances.
– Check the specific state taxing authority (or a tax professional) for exact filing and payment dates.
Practical steps for compliance and tax management
1. Determine nexus (where you owe franchise tax)
– Assess which states you “do business in” (sales, employees, property, physical presence, economic nexus rules). If you have nexus in a state that levies a franchise tax, you may be obligated to file/pay even if you’re formed elsewhere.
2. Identify entity classification and filing method
– Your entity type (C corp, S corp, LLC, LP, LLP) often determines the tax base and minimums. Some elections (e.g., LLC electing corporate treatment) change which tax applies—choose elections with long-term tax impacts in mind.
3. Know each state’s tax base and rates
– Learn whether your liability is based on net worth, capital, paid-in capital, gross receipts, or a flat fee. Examples: CA S-corporations = greater of $800 or 1.5% of net income; Delaware corporations have multiple calculation methods yielding a wide range.
4. Maintain good records for valuation and apportionment
– Keep up-to-date books and records of assets, capital, receipts and payroll. Proper apportionment (allocating income/assets among states) can reduce multi-state exposure.
5. Check for exemptions and credits
– Small-business thresholds, nonprofit status, targeted-incentive exemptions (e.g., for job creation or renewable energy projects) may reduce or eliminate franchise tax liabilities. Apply for eligible exemptions or credits timely.
6. Consider tax planning and entity structuring
– Actions such as shifting certain assets, altering paid-in capital, or electing a different tax classification (where allowable) can affect franchise tax. Always weigh long-term business and legal implications.
7. Timely file and pay; monitor for notices
– File state returns and pay on time to avoid penalties and loss of good standing. Respond promptly to any state notices and maintain proof of payments and filings.
8. Use professionals for multi-state complexity
– Multi-state apportionment, high-value assets and large/complex group structures often require state tax specialists or CPAs to optimize outcomes and ensure compliance.
Example calculations (simple)
– California S corporation example: net income = $200,000 → 1.5% × $200,000 = $3,000. The S-corp pays the greater of $800 or $3,000 → $3,000 due.
– Delaware LLC example: annual franchise tax for a Delaware LLC (formed in DE) = $300 minimum (per the cited Investopedia summary).
Franchise tax planning strategies (practical)
– Manage capital structure: since some states tax paid-in capital or stock value, evaluate timing of capital infusions and share issuance.
– Optimize apportionment factors: some states weight sales, payroll or property differently—structure operations to favor states with lower apportionment factors where legal and commercially sensible.
– Use deductions and credits at the state level: research state-specific incentives for hiring, investment, R&D and energy projects.
– Consider entity location and qualification: for startups, weigh the benefits of incorporating in jurisdictions with favorable franchise-tax regimes (but consider where you’ll actually do business, which can create nexus).
– Regularly reassess as laws change: states can change tax structures; monitor legislative developments.
What to do if you can’t pay
– Contact the state taxing authority early: ask about installment agreements or short-term relief programs.
– Negotiate penalties or payment plans where available.
– Prioritize resolving franchise tax debts to avoid suspension of good standing, liens or administrative dissolution.
The bottom line
Franchise taxes are state-level charges for the privilege of being a legal business in a state. They are separate from income taxes and vary widely by jurisdiction in basis, rates and exemptions. Proper nexus evaluation, entity selection, recordkeeping, awareness of exemptions and prompt filing/payments are the most effective ways to avoid penalties and manage franchise-tax burdens. For complex multi-state situations or material liabilities, consult a tax professional with state-tax experience.
Source
– Investopedia — “Franchise Tax” (https://www.investopedia.com/terms/f/franchise_tax.asp)
If you want, I can:
– Look up current franchise-tax deadlines and specific forms for a particular state,
– Walk through a multi-state apportionment example using your company’s facts, or
– Summarize franchise-tax rules for a shortlist of states you operate in. Which would be most helpful?