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15 Dec 2022

What Is Franchise Tax? All You Need to Know about Taxes and State Fees

One of the biggest responsibilities you have as a franchise owner is managing your business’s finances. Whether you handle the bookkeeping yourself, have an in-house accountant, or you outsource your accounting to a third-party firm, you’re still the one who has the final word on important financial decisions, and therefore the most responsibility. This means it’s important to know what expenses your business will regularly incur. Depending on the state(s) in which you operate, this may include franchise tax.

The Definition

So, what is a franchise tax? Simply put, a franchise tax is a state fee charged to businesses operating within a state for the privilege of doing business there. In some states, this is known as a privilege tax. Despite its name, this particular fee is charged separately from state and federal income taxes and may apply to non-franchise businesses, including corporations, partnerships, and limited liability corporations (LLCs) that operate within a particular state. You can think of a franchise tax as being like a business license. Both are required for your company to conduct business in each area where the issuing agency has authority.

The Calculation

The way that different states calculate their franchise tax fees will vary. Factors that play into a state’s franchise tax calculations include a company’s assets, net worth, and their capital stock. Some states charge a flat fee for their tax, while others base it off a company’s gross receipts or paid-in capital.

These taxes are set by different agencies, depending on the state. For many states, the Department of Revenue will be responsible for handling the taxes. Other states have a comptroller that levies its taxes and fees on businesses and corporations, while others employ a board or appointed body to do the job.

For an example of how different states calculate their franchise taxes, let’s look at Delaware. According to the Delaware Division of Corporations website, a corporation using the standard and authorized shares method, bases the tax on the number of authorized shares in a company’s charter, and pays a minimum franchise tax of $175 annually. A corporation using the assumed par value capital method, a method often used by new corporations based on the actual value of their company, pay a minimum of $400. Both methods of tax calculation have a maximum of $200,000, unless the filing corporation is defined as a large corporate filer, in which case the maximum is $250,000.

For comparison, let’s look at California. According to legal advice provided by LegalZoom, non-corporate businesses subject to franchise taxes pay a flat tax of $800. Corporations, meanwhile, pay either $800 or a portion of the corporation’s net income multiplied by its applicable corporate tax rate, whichever’s larger. This kind of variation between states is common.

Some states don’t have a franchise tax at all. In recent years several states, including Kansas, Missouri, Pennsylvania, and West Virginia, have all chosen to rescind these particular taxes. While this might make things easier financially for businesses in these states, it does call into question which states are still charging companies franchise taxes and why. This can result in confusion for companies operating in multiple states, some with taxes, some without. The state agencies which handle the state’s taxes will specify on their websites if they do or don’t charge businesses like yours a tax.

The Exceptions

There are exceptions to which organizations must pay them where they’re applicable. Fraternal organizations and nonprofits are exempt from franchise taxes as they’re not, strictly speaking, commercial businesses. However, certain limited liability companies are also exempt from these taxes as well. A good rule of thumb is: if your company has to register with a state, then you’re likely going to have to pay a franchise tax.

Additional entities exempt from franchise taxes include the following:

  • Sole proprietorships that aren’t single-member LLCs.
  • General partnerships directly owned by natural persons, except for limited liability partnerships.
  • Entities exempt under Tax Code Chapter 171, Subchapter B.
  • Certain unincorporated passive entities.
  • Certain grantor trusts, estates of natural persons, and escrows.
  • Real estate mortgage investment conduits and certain qualified real estate investment trusts.
  • Unincorporated political committees.
  • Trusts qualified under Internal Revenue Code Section 401(a).
  • Trusts which are exempt under Internal Revenue Code Section 501(c)(9).

The Rules

Franchise taxes are paid annually and the payment deadlines vary by state. State tax agencies will be able to tell you when and how to pay your taxes. Some of them, such as California, have online payment options. Late payments are tracked by these agencies and may carry a penalty. Again, these will vary by state, but common penalties include flat fines and interest rates. Heavier penalties may also include tax liens, lawsuits, loss of business protections, and loss of legal standing for your company.

Franchise taxes are state fees which businesses like yours must pay to operate within that state. Not all states charge them, and those that do calculate them differently. Each state agency which collects the taxes will be able to tell you how much your business must pay that state. Failure to pay these taxes can mean trouble for your company in that state, from fines to lawsuits to no longer being able to do business there. If you have questions about franchise taxes in one or more states where your company operates, contact that state’s government, or visit the state government’s website.

Stay Informed with MFV

Finding the answers to questions like “What is a franchise tax?” can be difficult, with numerous information sources of varying degrees of qualification and dependability out there. Having a trustworthy information source is important and, at MFV, we want to be that source for businesspeople like you. We’re a franchising network with over 30 years of experience bringing the franchise world together. We’re dedicated to providing business owners an abundance of information on a variety of subjects, including franchise financing, through our website, which includes blogs, up-to-date newsletters, and more. We’re also dedicated to helping franchisors and enterprising entrepreneurs connect. Our regular franchising expo events are attended by both companies seeing new members and motivated entrepreneurs looking for a franchise to join.

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