Some states require a franchise tax, which is a tax on businesses operating or chartered within that state's borders.
Depending on the state, the exact name of the franchise tax may vary. Alternative names include: business entity income tax, business privilege tax, business profits tax, commerce tax, corporate franchise tax, net worth tax, and unincorporated business franchise tax.
A franchise tax differs from state income tax, which is calculated on the business's profit. A franchise tax may apply to a business regardless of whether or not it earned any income in the state if it otherwise meets the requirements to file and pay the tax.
Tax nexus and franchise tax
Nexus is a legal term used to describe a connection between a taxing entity, such as a state, and a business entity. If a business has nexus in the state, it has sufficient presence in the state to incur a tax. The state determines the nexus required for a franchise tax, and this varies among the states. The two common methods of determining nexus are whether the business has a physical presence or an economic presence in the state.
Physical presence
A business has a physical presence in a state if it has a physical location, whether it owns or leases property, in the state. Alternatively, it may have employees, such as a traveling sales team, that reside in the state.
Economic presence
A business has an economic presence if it meets the state's threshold for total revenue earned or the number of transactions completed. Even if the business does not have a physical location in the state, it may derive a sufficient amount of income from doing business within the state to satisfy the state's economic presence nexus requirement.
Who is required to pay franchise tax?
Each state determines what businesses must pay its franchise tax. Some states only require C corporations to pay the franchise tax. S corporations, partnerships, and limited liability companies (LLCs) are also required to pay in other states. Some have taxes specific to unincorporated businesses. Many apply to all business types.
Certain states may exempt an entity based on the type of business it conducts in the state. For example, small incorporated farming businesses are exempt in certain states. It is important to know the specific requirements for the states in which you may have nexus.
States requiring franchise tax
As of 2021, eighteen states impose some form of franchise tax on businesses operating within their borders. The states are Alabama, Arkansas, California, Delaware, Georgia, Illinois, Louisiana, Mississippi, Missouri, Minnesota, Nevada, New Hampshire, New York, North Carolina, Oklahoma, Tennessee, Texas, Vermont, and the District of Columbia. The franchise tax in Illinois will phase out through 2024.
How is franchise tax calculated?
Each state calculates its franchise tax differently. The most common calculation methods are:
- A percentage of the business's net worth
- A percentage of the book value of the business's real or personal property located within the state
- A percentage of the value of the business's capital stock
- A flat fee for all businesses subject to the tax
Minimum and maximum limits
Depending on the state, businesses with a net worth beneath a specific threshold may be exempt from the franchise tax. Other states require a minimum franchise tax regardless of whether the business had any income during the year. Some states also set a maximum franchise fee for all businesses over a certain net worth.
Franchise tax vs. state income tax
States with franchise taxes may collect them even if they also have a state income tax. A franchise tax differs from an income tax because it is not based on a percentage of the business's profits. A business with no profit may still be subject to a franchise tax.
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FAQs
Franchise tax stands as a distinct obligation, differing fundamentally from income tax. States levy this tax on businesses for the privilege of operating, incorporating, or maintaining a legal entity within their jurisdiction.
What is the meaning of franchise tax? ›
What Is a Franchise Tax? The term franchise tax refers to a tax paid by certain enterprises that want to do business in some states. Also called a privilege tax, it gives the business the right to be chartered and/or to operate within that state.
What is franchise tax in California? ›
The California Franchise Tax rates depend on your business's tax classification: C corporations: 8.84% S corporations: 1.5% Partnerships (such as LLCs, LPs, LLPs, LLLPs): $800.
Does every state have franchise tax? ›
States requiring franchise tax
The states are Alabama, Arkansas, California, Delaware, Georgia, Illinois, Louisiana, Mississippi, Missouri, Minnesota, Nevada, New Hampshire, New York, North Carolina, Oklahoma, Tennessee, Texas, Vermont, and the District of Columbia.
How to calculate franchise tax in Texas? ›
Franchise tax is based on a taxable entity's margin. Unless a taxable entity qualifies and chooses to file using the EZ computation, the tax base is the taxable entity's margin and is computed in one of the following ways: total revenue times 70 percent; total revenue minus cost of goods sold (COGS);
Can I claim franchise tax on my taxes? ›
Franchise Specific Tax Deduction Tips
Note: Franchise fees are categorized as Section 197 Intangibles by the IRS and are not immediately tax-deductible. The IRS requires you to amortize the franchise fee over 15 years. This allows you to recover the cost over time for tax purposes.
Is franchise tax the same as federal tax? ›
A franchise tax is a state tax imposed on businesses or for-profit corporations doing business in the state. Because the primary purpose of a franchise tax is to raise revenue for the state, a franchise tax is distinct from federal taxes, such as income or excise tax.
When to pay California franchise tax? ›
For LLCs, the first-year annual franchise tax is due the 15th day of the fourth month from the date you file your business with the secretary of state. In subsequent years, the annual tax becomes due on the 15th day of the fourth month of your taxable year, which is generally April 15.
What happens if you don't pay California franchise tax? ›
Generally speaking the FTB will begin collection actions 90 days after the delinquency and it could include bank levies and wage garnishments. Court Costs. If you owe money for unpaid tickets or fines, the Franchise Tax Board will be charged with collecting those fees plus any late fees and delinquencies.
What is franchise tax withholding? ›
In a nutshell, California law requires a buyer to withhold 3.33% of the sales price and send it to the Franchise Tax Board as a “prepayment” of the state tax a seller owes on the sale of real estate.
California is a registration state, meaning it requires registration of business opportunities. Franchisors must apply for registration of the FDD with the California Department of Business Oversight in accordance with 10 CA ADC § 310.111.
Is Texas a franchise tax? ›
The Texas franchise tax is a privilege tax imposed on each taxable entity formed or organized in Texas or doing business in Texas. For general information, see the Franchise Tax Overview.
Is Franchise Tax Board state or federal taxes? ›
The Franchise Tax Board (FTB) is the agency responsible for collecting state personal income taxes in California.
What is a franchise fee tax? ›
In fact, most corporations, partnerships, and limited liability companies (LLCs) are subject to it. Franchise tax is a business tax charged by many states or cities for the privilege of doing business within their borders. It's often referred to as a “privilege tax” for this very reason.
What is franchise tax in Delaware? ›
Franchise Tax is the fee imposed by the State of Delaware for the right or privilege to own a Delaware company. The Delaware Franchise Tax has no bearing on income or company activity; it is simply required by the State of Delaware to maintain the good standing status of your company.
Do you have to pay franchise tax if less than $1000 in Texas? ›
Minimum Franchise Tax
There is no minimum tax requirement under the franchise tax provisions. An entity that calculates an amount of tax due that is less than $1,000 or that has annualized total revenue less than or equal to $1,180,000 is not required to pay any tax.
Who has to pay Texas franchise tax? ›
Texas Tax Code Section 171.001 imposes franchise tax on each taxable entity that is formed in or doing business in Texas. Taxable entities may need to file franchise tax and information reports each year.
Is franchise tax an expense or liability? ›
The tax is typically recorded in the accounting records as an expense.
Are there tax benefits to owning a franchise? ›
Potential Tax Advantages. Leveraging Tax Deductions: Business expenses such as payroll, ongoing franchise royalties, lease payments, equipment, supplies, and utilities are generally fully deductible in the year they are incurred, reducing taxable income.
