Every business that has a presence in the United States must pay certain business taxes. These taxes can range from the well-known income tax to the lesser-known franchise tax. For many businesses, the U.S. taxation system can be confusing.
In this article, we will discuss the franchise tax definition, rates, discussions, and variations across states.
What is a Franchise Tax?
A franchise tax is a tax that a state levies on the businesses operating within its boundaries. Also known as a privilege tax, this tax is mandatory and is paid once a year in return for allowing a business to work in that state. This corporate tax is a source of revenue for the state and is mostly used to support its infrastructure and public services. It must be paid by corporations (C-Corp and S-Corp), limited partnerships, limited liability partnerships, and limited liability companies. It does not apply to sole proprietorships and general partnerships.
Understanding Franchise Taxes – How They Work?
Franchise tax rates and their calculations vary across states. Some states charge a flat fee for certain types of organizations, while others may calculate this tax based on factors like gross receipts, authorized shares, net worth, and capital stock.
Franchise Tax Rates by State
Since franchise tax rates vary between states and organization types, you must understand which category you fall under. Below are the calculations for prominent states like Delaware, California, Wyoming, and Georgia.
Delaware Franchise Tax Rates
In Delaware, the minimum franchise tax depends on the method used to compute it. This tax is $175 for corporations that use the Authorized Shares method and $400 under the Assumed Par Value Capital method. The maximum Delaware franchise tax under both methods is $200,000 per year.
It is an accepted practice that companies that don’t have par value stock use the authorized shares method. Under this method, the rate is:
- $175 for up to 5,000 shares.
- $250 for 5,001 to 10,000 shares.
- Add another $85 to every additional $10,000 shares.
- The maximum is $200,000.
If you want to use the assumed par value method, include all issued shares and total gross assets for the calculation. The steps for calculating are:
- Divide total gross assets by total issued shares. This is your assumed par.
- Multiply the assumed par by the number of authorized shares that have a lesser value than the assumed par.
- Similarly, multiply the assumed par by the number of authorized shares that have a higher value than the assumed par.
- Add 2 and 3 to get the assumed par value capital.
- Round this assumed par value capital to the next million and divide it by 1,000,000. Multiply by $400.
The maximum amount is $200,000 in this method too.
The due date is March 1st for corporations and June 1st for partnerships and LLCs.
California Franchise Tax Rates
In California, the minimum franchise rate is $800. It applies to S-Corporations that meet at least one of these requirements: incorporated, doing business, registered to do business, or receiving source income from California. The tax rate is 1.5% of California’s source income. The minimum California franchise tax amount of $800 is due within the first quarter of each accounting period.
Wyoming Franchise Tax Rates
In Wyoming, every business pays a license tax based on all the assets located and employed in Wyoming. The Wyoming franchise tax rate is $0.0002 per $1 of your assets (i.e., 0.02%) or $60, whichever is higher. This amount must be paid on the anniversary month of formation. For example, if a business was registered on January 15th, this amount must be paid before January 1st.
Georgia Franchise Tax Rates
In Georgia, the franchise tax is called the net worth tax, as it is calculated based on a company’s total net worth, and not on its income. The due date is April 15th.
Depending on the state in which you operate, calculate the franchise tax and pay it before the due date.
State vs. Federal Franchise Taxes
In the United States, there is no federal franchise tax. These taxes are levied only by the states in return for allowing a business to operate in that state. However, the federal government levies an income tax rate of 21% on corporations, and this must be paid every year.
Many differences stand out when you compare the state’s franchise taxes and the federal income tax rate. Firstly, the federal tax applies to all companies, and is based on the total taxable income minus the allowed deductions. State franchise tax, on the other hand, is levied by specific states only and applies only to the businesses that operate in that state.
Note that businesses must pay both these taxes.
Who Is Exempt from Franchise Taxes?
Not all businesses need to pay franchise taxes. Depending on each state, the following entities get an exemption:
- Small businesses
- Nonprofit organizations
- Other special exemptions
However, some states require all entities to file an annual report, even if they don’t meet the requirements of a franchise tax.
If you are unsure about exemptions, talk to the experts at Manay CPA.
What Happens If You Don’t Pay Your Franchise Tax?
It is always a good idea to pay your franchise tax on time because they are minimal and affordable. The consequences of not paying can be big for your business. You can incur one or more of the following due to non-payment:
- Penalties and interest charges – for example, California charges a 5% penalty plus 0.5% per month for up to 40 months.
- Business suspension or resolution
- Personal liability risks
- Inability to do legal activities
In case of difficulties, you can approach the state government and set up a payment plan for your overdue taxes. However, make sure to stick to the agreed payment plan.
Franchise Tax vs. Income Tax – Key Differences
Even a quick analysis shows that these taxes are completely different and are applied in different ways. Knowing these differences can help businesses to plan their finances better to avoid penalties.
Firstly, franchise tax is a fee that businesses pay for the privilege of doing business in a state, regardless of whether a business earns a profit or not. On the other hand, federal tax is paid as a percentage of the profits earned by the company. If a company does not earn a profit in a given year, there is no income tax, subject to IRS provisions.
Next, the federal income tax is paid by every business that operates in the United States, regardless of how it is structured. Though the taxation rates may vary, there is no exemption from the income tax. Franchise taxes, in contrast, are levied only by some states. Even within those states, some organizations are exempt from paying them. Moreover, the income tax is a federal tax that is collected by the federal government and used for national activities, while the franchise tax is collected by the respective state governments and is used for improving the state’s infrastructure.
Lastly, the calculation method varies. The income tax is calculated on the profits after allowing for some deductions, but a franchise tax can be a flat fee or calculated based on authorized shares, net worth, or income earned from the state.
Overall, both taxes serve different purposes and have their own calculations. In case of doubts about how these taxes are calculated, reach out to experts.
Example of How Franchise Tax Works
Understanding the franchise tax calculations in each state will help you determine the right amount. Below are practical examples of how it is calculated in each state:
Delaware
Let us assume that a C-corp in Delaware has 1,000,000 authorized shares. Below is the calculation:
- The base fee for 10,000 shares is $250.
- The remaining shares are 990,000.
- When you divide 990,000 by 10,000, the answer is 99.
- Multiply each increment by $85,99 X $85 = $8,415.
- Finally, add the base fee.
The total franchise tax of $8,665.
California
The California franchise tax for LLCs includes two components. Let us assume an LLC earns $750,000. The total amount payable is calculated as follows:
- The base franchise tax is $800.
- Additionally, there is a California Annual LLC fee, which is not officially part of the franchise tax but is based on the LLC’s total gross receipts.
- For income between $500,000 and $999,999, the applicable gross receipts fee is $2,500.
The total comes to $2,500 + $800 = $3,300.
Wyoming
Let us assume a business has $5,000,000 in assets. The calculator is:
- The base rate is $60 for assets up to $300,000.
- Since it is more, the calculation is $5,000,000 X 0.002 = $1,000.
The total franchise tax is $1,000.
Georgia
Georgia has a franchise tax slab based on net worth. If the net worth of your company is $500,000, the corresponding tax slab amounts to $300.
These examples can help you make the calculations for your business.
Tax Planning Strategies for Franchise Taxes
Though the franchise tax is not a big burden, businesses can still take steps to reduce the amount they pay. Here are some tax planning strategies:
- Choose the right state based on your business earnings. For example, if your business earns a high income but has only a few assets, Wyoming is the right place because the franchise tax is calculated based on the asset value.
- Understand how tax works in your state and plan accordingly.
- Select the right calculation method, especially in states like Delaware that offer multiple options.
- Some states offer credits when you meet certain criteria.
- Work with experienced firms like Manay CPA to bring down your tax obligations.
Special Considerations for Business Owners
Franchise tax calculations can become complex for those businesses that operate in multiple states or when tax structures are revised. The following scenarios warrant special considerations.
Multi-State Businesses
Businesses that operate in more than one state must pay this corporate tax in each state. Two aspects define a nexus. If a business has a physical presence with an office and employees, or if the business gets revenue from a state, it must pay a franchise tax. For example, a company registered in Delaware sells products to customers in California. It must pay the California and Delaware franchise tax.
Changing Franchise Tax Laws
States may revise their tax laws to attract more businesses. These changes can impact existing and new businesses. For example, Texas raised its no-tax-due threshold in 2024 to attract more small businesses.
Businesses must stay on top of these regulations and changes to avoid penalties.
The Franchise Tax Board – What You Need to Know
The Franchise Tax Board (FTB) is California’s tax agency. It assesses, collects, and processes the state’s taxes. It can also order audits and impose penalties for non-compliance.
A key difference between the FTB and the IRS is that the FTB pertains only to California, while the IRS pertains to the entire country. Also, the FTB is responsible for collecting franchise tax and has jurisdiction only over businesses operating in California.
When Are Franchise Taxes Due?
Franchise tax deadlines vary by state. Read on to know the deadlines for the prominent states, and make sure to adhere to them:
- Delaware – March 1st for corporations and June 1st for partnerships and LLCs.
- California – The $800 franchise tax is due within the first quarter of the taxable year, especially for new entities. Note: April 15th is the deadline for filing returns, not for making the initial payment.
- Wyoming – Anniversary of registration.
- Georgia – April 15th.
The Bottom Line – Is Franchise Tax a Concern for Your Business?
To conclude, a franchise tax is paid by businesses to the states in which they operate. This is a privilege tax that businesses pay for being allowed to operate in that state. In this guide, we discussed in detail how to calculate, when to file, and what happens due to non-compliance. This information can help you to plan well and pay these taxes on time to avoid financial penalties and reputational loss.
Despite this information, computations can get complex. Manay CPA has many decades of experience handling franchise taxes, so schedule a free consultation with them to get started.
