How Businesses Pay Franchise Taxes
Many U.S. states have taxes on business income, in various forms. Some states tax only corporations, while others tax most business types. States call these taxes different things, and meanings get confused.
What is a Franchise Tax?
A franchise tax is charged by a state to businesses for the privilege of incorporating or doing business in that state. Franchise taxes, like income taxes, are usually imposed annually. Failure to pay franchise taxes can result in a business becoming disqualified from doing business in a state.
Any business that is required to register with a state, including corporations, partnerships, and LLC's, may be charged a franchise tax. Sole proprietorships are not usually subject to franchise taxes and other forms of state business income tax, because these businesses are not formally registered with the state in which they do business.
Franchise taxes are imposed on companies that "do business" in a state; this is the concept of nexus. Determining nexus is complicated, including whether or not the business sells in the state, has employees in the state, or has a physical location in the state.
A business may do business in several states (depending on how the state views the business), and usually, the business is formally registered in the state, or in multiple states. If your business is formally registered in several states, you will probably have to pay franchise taxes in several states, if you do business in those states.
A franchise tax is not a tax on franchises. That is, it's not a way to tax all the McDonald's franchises in a state.
Franchise Taxes vs. Business Income Taxes
All businesses pay income taxes. but only corporations pay income taxes directly. These income taxes are based on the profit of the corporation. Corporations may pay both federal income tax and state income tax if the state has an income tax. Some states require businesses to pay both income tax and franchise tax.
Franchise Taxes vs. Annual Reports or Biennial Reports
Some states have an annual report that businesses are required to file. Of course, the report also comes with a fee. Florida, for example, has an annual report. Other states, like Iowa, have a biennial report that must be filed every other year.
Franchise Taxes vs. Gross Receipts Tax
A gross receipts tax is a tax on sales. It's not taxing the customer, but it's taxing the seller. It's similar to a franchise tax, but it taxes a different way.
Why Franchise Taxes May Not Be Good for Business
You'll notice in the definition, I used the word "privilege." A franchise tax is what's called a "privilege" tax, meaning that it is imposed on entities for the privilege of doing business in the state. Some states (like Louisiana) have both income taxes and franchise taxes. This makes the effective tax rate in these states higher, and it has the effect of driving business from the state.
The Heartland Institute says that franchise taxes are being eliminated in some states (like West Virginia), to encourage business growth.
What States Have Franchise Taxes
The states that currently have franchise taxes are: Alabama, Arkansas, Delaware, Georgia, Illinois, Louisiana, Mississippi, Missouri, New York, North Carolina, Oklahoma, Pennsylvania, Tennessee, Texas, and West Virginia.
Most of these states have franchise taxes in addition to state income taxes. Delaware also has a gross receipts tax, in addition to state income tax and franchise tax.
States change their tax laws, and this list may not be up to date, so be sure to check with your state to find out if it has a franchise tax.
How States Determine Franchise Taxes
Each state has different criteria for determining what type of business entities must pay franchise taxes, the basis for the tax (either income or capital), and the tax rate.
States base franchise taxes on differing criteria. Each of these descriptions is defined specifically by the state or state:
- income (thus, the franchise tax is really an income tax)
- par value of stock, shares of stock, or value of capital stock, or authorized shares,
- gross assets
- flat amount, or an amount up to a certain amount of assets,
- tangible property or assets (not including intangible assets)
- "taxable" capital (as defined by the state)
- paid-in capital
- net worth
- assess value of real and tangible personal property or net investment in tangible personal property
- gross receipts (this tax is really a gross receipts tax)
Some Examples of How Franchise Taxes are Computed by States
Note: These are brief overviews; use the links to go to the state websites for more details.
Texas has a franchise tax on most business entities, but not on sole proprietorships. The tax is based on what the state calls "margin," which is total revenue adjusted in one of 4 ways:
- Total revenue times 70%
- Total revenue minus Cost of Goods Sold
- Total revenue minus compensation, or
- Total revenue minus $1 million.
This article from the Texas Comptroller of Public Accounts has more details.
California has a Franchise Tax Board, and this board administers and collects income taxes from businesses and individual taxpayers.
Louisiana has both income tax and franchise tax on businesses. The income tax and franchise tax are both imposed on corporations, or entities taxed as corporations. The franchise tax is imposed on "capital employed in Louisiana" and the rate is:
$1.50 for each $1,000 or major fraction thereof up to $300,000 of capital employed in Louisiana, and $3 for each $1,000 or major fraction thereof in excess of $300,000 of capital employed in Louisiana.
How Do I Get Set Up to Pay Franchise Taxes in My State?
Most businesses (except sole proprietors) must register with the state in which they will be doing business. So, if you are starting a corporation, partnership, or LLC, you register by filing an application for that specific business type. Your state will contact you after you have registered your business.
You can Also check with your state department of revenueto determine whether your state has a franchise tax or another annual tax on businesses.