The Complete Guide to Franchise Tax
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This article has been reviewed by tax expert Erica Gellerman, CPA.
Some business taxes such as payroll tax, sales tax and even self-employment tax are somewhat self-explanatory. But franchise tax can be a little bit more confusing — in part, due to its name — leaving many new small business owners to wonder: “What exactly is a franchise tax, and does it apply to me?”
Franchise tax actually has nothing to do with whether or not a business is a franchise. So even if you don’t own a fast food chain restaurant, keep reading to learn all about franchise tax and whether it impacts your business.
What is franchise tax?
Put simply, a franchise tax is one that the state levies against a business simply for doing business in that state. Each state’s franchise tax varies and some states have it in addition to or instead of income tax or other small business taxes. Which businesses pay it, how it’s calculated and some other details all differ from state to state — more on that later.
A franchise tax is charged to some businesses that either do business or are incorporated in a certain state. A business can even owe a franchise tax for simply owning property in a state. Some types of businesses are exempt in certain states, so it’s important to check the specifics of the franchise tax in any state where your business is incorporated or does business.
Be sure to note that a franchise tax is sometimes also called a privilege tax. It gets that name because it’s levied against a business for the privilege of doing business in a particular state. It’s different from an income tax, which most businesses also pay. A franchise tax is not based on profit, and is mandatory whether a business is profitable or not.
Who has to pay franchise tax?
Usually businesses that are required to register with the state are also required to pay a franchise tax. Businesses owned and operated by one person, or sole proprietors, aren’t subject to franchise tax in some states where they aren’t required 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. Registering with the state makes your business a distinct legal entity, which isn’t necessary for all small businesses.
“In some cases, you don’t need to register at all. If you conduct business as yourself using your legal name, you won’t need to register anywhere,” according to the SBA.
To determine whether you need to register your business, you need to have the location and the business structure of the business determined and clear.
Which states have franchise tax?
Only some states have businesses pay some sort of a franchise tax. These taxes can be charged in addition to the other states taxes. As of 2019 the states with a type of franchise tax were: 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 eliminated?
The business franchise tax in West Virginia was eliminated in 2015, eliminated in Kansas in 2011. It's also been eliminated in Missouri and Pennsylvania.
A franchise tax is different from the standard income tax a business pays when filing taxes each year. The IRS has a helpful website that shows income tax details for different business structures like partnerships and limited liability companies, or LLCs, on a federal level.
How much is franchise tax and how to calculate it?
The rate for franchise taxes varies from state to state just like the other rules around the tax do. Rules around these taxes vary based on the location of and the type of business you run and own, which is why it’s so important to be aware of the specifics of the franchise tax in your state.
Franchise tax is a flat rate in some states, which makes it easy to calculate depending on the type of business you have. Elsewhere though, the tax is calculated a number of ways. Metrics that can be used to determine the tax include: percentage of the assets of a business, a percentage of the net worth of the business or even the gross receipts of the business for the tax year. It’s, however, not related to the income of a business in a given year.
Delaware has some of the highest rates of any state that collects it. There, the lowest the franchise tax will be for any business is $175 and the total tax can be calculated several ways. Those non-stock for-profit businesses will pay $175. Businesses can also calculate their franchise tax in Delaware using the Authorized Shares Method or the Assumed Par Value Capital Method. The methods are detailed on the Delaware Division of Corporations website, and some have a higher minimum cost than others do.
Most states, like Delaware, have calculators or details on how to calculate the specific tax on their website. Each state calculates the tax differently, so it’s best to double-check before filing. Some states, like New York, require business owners to calculate their tax several ways and then pay the highest calculation.
Who collects franchise tax?
This, too, varies from state to state. Depending on where you’re paying the franchise tax, different departments within the state government are responsible for collecting the tax.
In Texas, where the franchise tax is described as “a privilege tax imposed on each taxable entity formed or organized in Texas or doing business in Texas,” the Comptroller’s Officehandles the tax collection. In California, on the other hand, there’s a designated Franchise Tax Board responsible for collecting the tax.
What are the legal ramifications for not paying franchise tax?
Business owners who fail to pay their franchise tax can face ramifications that could threaten their business as a whole, so it’s important you stay on top of any tax you owe. If you fail to pay your taxes, you’ll likely receive a notice from the department responsible for collecting the taxes. If the tax still goes unpaid, then you might face a tax lien. This is a good chance to get on a payment plan to start paying back what you owe.
Businesses that fail to pay their franchise tax can also lose their legal standing and therefore the ability to do business or remain in binding contracts in the state. They could also lose the standing to file lawsuits or be part of any legal action as well.
An LLC can potentially lose its protections as an LLC if you fail to pay the franchise tax for it. That would leave management or owners open to financial liability or vulnerability.
What are the deadlines for paying franchise tax?
Franchise taxes are annual taxes, so just because you pay them one year doesn’t mean you’re off the hook. Like the rates, along with which businesses are responsible for paying franchise taxes, when they’re due also varies from state to state.
Just like with any other tax, there are strict deadlines for franchise taxes and late fees if you miss the deadline. Some states use specific due dates for the tax to be due. It can vary depending on the type of business you have. In Delaware the due date is March 1 for corporations but not until June 1 for LLCs. In some states it’s due on the 15th day of the third or fourth month of the tax year.
Sometimes the date has to do with the anniversary of when the business was officially formed instead of a certain tax due date across the board. This would make the tax due in the same month as the business anniversary.
You can find the due date for the tax in your state on the state’s website. Each state has its deadlines listed, usually on the same site where the details about the tax are available. Deadlines following a granted extension should also be available in the same place online.
A version of this article was first published on Fundera, a subsidiary of NerdWallet