What is Franchise Tax? The Ultimate Guide
Several business taxes are self-explanatory, like payroll, self-employment, or sales taxes, but not franchise taxes. This tax confuses most business owners because of its name. So, what is franchise tax? How is it calculated, and how do states decide franchise taxes? This guide will help you learn franchise tax has nothing to do with franchise business. It would be helpful to read to the end and know if it affects your company.
Understanding Franchise Tax
Franchise tax is a tax some states of the US put on businesses operating in their jurisdiction. The franchise tax varies depending on your state. You can owe franchise tax in some states for owning a property in that state.
More so, the franchise levy doesn't replace state income or federal taxes; it is an add-on tax that you must pay annually. That's why reviewing the specifics of franchise tax in the state where you formed your company is crucial.
However, some states exempt certain types of businesses, such as non-profit organizations and small businesses, from franchise tax. Your company will be charged tax according to its total net worth or company assets.
Calculating this tax is complicated because of the state rules. You must adhere to the rules as per your state, because failure may result in penalties and interest charges. To stay in compliance with franchise tax, you seek the help of a tax expert.
This tax is an excellent revenue source for the state since it helps fund infrastructure projects and other developments like education, healthcare, etc. The franchise tax board will collect the tax based on state rules. It is levied on all businesses like:
- Corporations
- Partnerships
- Limited liability companies
- Sole proprietors
States that Implement Franchise Tax
Here are some US states that implement the franchise tax:
- Arkansas
- Alabama
- California
- Delaware
- Georgia
- Illinois
- Louisiana
- Texas
- New York
However, some states have stopped imposing the franchise tax. States like
- Kansas
- Pennsylvania
- Missouri
- West Virginia
How a State Decides the Franchise Tax
Each state bases the franchise tax on unique criteria such as:
- Income
- Net worth
- The par value of authorized shares, stock or stock
- Gross assets
- Flat fee rate
- Paid in capital
- Tangible person properties
- Gross receipts
Additional Considerations
Although most businesses pay the franchise tax depending on the state where they are registered or operate, the company sole proprietorship is exempted from paying franchise tax. This is because these businesses are not registered in the state where they work. There are also entities not subject to this tax, including
- Partnerships where ownership is not legally defined.
- Real estate mortgage investment conduits (REMICs) and specific real estate investment trusts (REITs).
- The trust meets the Internal Revenue Code Section 401(a) criteria.
- Unincorporated political committees.
- Specific grantor trusts, escrows, and estates of individuals.
- Trust is exempted under Internal Revenue Code Section 501(c)(9)
How is Franchise Tax Calculated?
Franchise tax board uses several methods to calculate the levy. Let's check some methods:
Business Profit Margin
Under the profit margin method, you calculate your business revenue and subtract costs and expenses. Then, multiply your margin by the business percentage in that state. For example, if a company does 50% of its business in a state, you will calculate the tax on the 50% margin. A business operating entirely in the state will pay a franchise tax on its 100% business profits. Then, the calculated margin is taxed per the state's applicable tax rates.
For example
Revenue- $10,000
Expense incurred -$5,000
Tax rate 10%
You will calculate the franchise tax on the profit margin as follows
$10,000 - $5,000= $5,000
$5,000 x 10%= $500
Authorized by Shared Methods
In this method, you multiply the number of authorized shares per the business charter by the recommended tax per share.
For example
If a company has 3,000 authorized shares, the state levies a franchise tax of $3 per share. The tax calculation will be as follows
$3 x 3,000= $9,000
What Happens when you do not Pay the Franchise Tax
Failing to pay your franchise tax could threaten your business, so you must pay your tax before the deadlines. If you don't pay, you may receive a notice from the franchise tax board, and if you don't pay up, you may face a tax lien.
Companies that neglect to fulfill their franchise tax obligations may face consequences such as:
- Losing their legal status
- Jeopardizing their capacity to conduct business
- Uphold contractual agreements within the state
- Initiate lawsuits, or
- Participating in legal proceedings.
An LLC can lose its LLC protection if you fail to fulfill the franchise tax for it. This means the owners and management will face the company's financial liability.
Does Franchise Tax have a Deadline?
Yes, just like any other taxes, franchise taxes have strict deadlines, and you must pay late fees when you miss the deadline. Some states have specific due dates; however, this may vary depending on your entity type. For example, in Delaware, corporations' franchise tax due date is 1st March, but LLCs have until 1st June. In other states, the due date falls on the 15th day of the third month of the tax year.
In other cases, the franchise tax due date is the same day as your company's anniversary. The due date is the same day and month you incorporated your corporation. If you don't know when to file your franchise tax, check it on your state's website. This is because every state has its deadline listed.
Franchise Tax vs. the State Income Tax
There is a significant difference between the income and the franchise tax. Their main difference is income tax is based on the company's profits, while franchise tax is not. Whether your company makes profits or losses, you must pay your franchise tax, but you only file the income tax based on your business earnings that year.
Frequently Asked Questions about Franchise Tax
1. What is Franchise Tax?
Franchise tax is a tax levied by some states on businesses for the privilege of operating within that state. It is not necessarily related to franchised businesses but is a tax on the privilege of doing business.
2. Which States Impose Franchise Tax?
Several states impose franchise taxes, including but not limited to Texas, Delaware, Alabama, and Louisiana. Each state has its own rules and calculation methods.
3. What Entities are Subject to Franchise Tax?
The entities subject to franchise tax can vary by state. In some states, it applies to corporations, limited liability companies (LLCs), partnerships, and other business structures.
4. How is Franchise Tax Calculated?
The calculation method varies by state. It may be based on factors such as the entity's net worth, capital, gross receipts, or a combination of these factors. Some states have a flat fee, while others have a more complex formula.
5. When is the Franchise Tax Due?
The due date for franchise tax payments varies by state. It may be annually, biennially, or according to another schedule. It's crucial to know and comply with the deadlines in the specific jurisdiction.
6. Are There Exemptions to Franchise Tax?
Some states may provide exemptions or reduced rates for certain entities or types of businesses. Exemptions could apply based on factors such as size, revenue, or industry.
7. What Happens If I Don't Pay Franchise Tax?
Consequences for non-payment vary by state but can include penalties, interest, and in extreme cases, the revocation of the entity's authority to do business in the state.
8. Do Franchise Taxes Apply to Small Businesses?
The applicability of franchise taxes to small businesses depends on the state's rules. Some states may have exemptions or reduced rates for businesses below a certain size.
9. Can Franchise Tax be Deducted on Federal Income Tax Returns?
In general, franchise tax payments are not deductible as a business expense on federal income tax returns. However, it's advisable to consult with a tax professional for specific guidance.
10. Is Franchise Tax the Same as Income Tax?
No, franchise tax is a separate tax from income tax. While income tax is based on a business's profits, franchise tax is often based on the privilege of doing business within a particular jurisdiction.
11. Can Franchise Tax Rates Change?
Yes, the rates and rules for franchise tax can be subject to legislative changes. It's important to stay informed about updates to the tax laws in the relevant jurisdiction.
12. Are Franchise Taxes the Same Across States?
No, franchise taxes can vary significantly from one state to another in terms of calculation methods, rates, and exemptions
Winding up
Franchise tax is a state tax for businesses in some states in the US. It's calculated based on factors like income and authorized shares. Ensure you meet deadlines, and remember not paying can lead to severe consequences, affecting a company's legal status. You must understand and fulfill your franchise tax obligations to avoid harsh penalties. You may also seek professional advice if you need help calculating the franchise tax.
