You must be aware of numerous taxes as a business owner. One tax you might have to pay to your state is the franchise tax.
As the name implies, franchise taxes are not taxes on franchise businesses. Instead, states impose a tax on particular entities, such as corporations and limited liability firms, for the privilege of doing business in their territory.
But what exactly is a franchise tax? In this article, learn more about this type of tax and whether or not it applies to your firm.
Table of Content
- What does franchise tax mean?
- Who pays franchise tax?
- How much does the franchise tax cost, and how does it calculated?
- Which states have franchise tax?
- Income Tax vs. Franchise Tax
- How to pay franchise tax
- Final Thoughts
What does franchise tax mean?
A franchise tax is a fee imposed by a state on a company for doing business in that state. This tax is different in each state, and some states levy it in addition to or instead of income taxes or other small business taxes.
A franchise tax applies to some firms that do business or have establishments in a specified state. Even having property in a state can result in a franchise tax bill.
Some firms are exempt from the franchise tax in some states. Therefore, examine the franchise tax details in each state where your company is incorporated or does business. It’s worth noting that a franchise tax is also known as a privilege tax.
Who pays franchise tax?
If the state in which they operate applies a franchise tax, many business entities, such as limited liability companies (LLCs) and corporations, must pay it.
Some businesses, such as the following, may be excluded from paying and reporting franchise taxes:
- Nonprofits organization
- Some limited liability companies (LLCs), sole proprietorships, and general partnerships
- Real estate mortgage investment conduits (REMICs) and some real estate investment trusts (REITs)
- Certain grantor trusts, estates, and escrows.
Find out if your company or organization qualifies for a franchise tax exemption in the state(s) where you do business.
How much does the franchise tax cost, and how does it calculated?
The rate of franchise tax varies from state to state. However, states with a higher corporation tax rate tend to have a lower franchise tax rate, and vice versa. In many states, the franchise tax is a flat rate, meaning that the rate taxed is the same for all businesses.
However, in some states, the franchise tax rate is greatly influenced by various criteria, such as the size and type of your business, its unique location, and much more, making calculating your franchise tax a hassle.
Most state government websites provide calculators determining whether a company pays franchise tax and how much it owes.
The minimal yearly franchise tax in Delaware, for example, is $175. On the other hand, businesses in California must pay a franchise tax of 1.5% of their net income, with a minimum of $800 per year. A company in Texas is free from paying franchise tax unless it generates a particular amount of gain ($1,180,000).
Which states have franchise tax?
Only a few states require firms to pay a franchise tax. The state might add these taxes on top of any existing state taxes. Alabama, Arkansas, California, Delaware, Georgia, Illinois, Louisiana, Mississippi, New York, North Carolina, Oklahoma, Tennessee, and Texas were the states with a franchise tax. A franchise tax also applies in Washington D.C.
The business franchise tax was removed in West Virginia in 2015 and Kansas in 2011. In Missouri and Pennsylvania, it has likewise been eliminated.
Income Tax vs. Franchise Tax
In several aspects, a franchise tax is distinct from an income tax. Franchise taxes, for example, are not based on business profits, but income taxes are. A firm must pay franchise tax regardless of whether it makes a profit, whereas income tax calculation depends on the organization’s earnings for the year.
Furthermore, even if their business does not operate within the states’ limits, income taxes are levied on companies that earn money from those areas.
The term “operating” is defined differently in each state. For example, many jurisdictions may consider selling or offering their services and goods in a given state or having employees live there to be operational.
How to pay franchise tax
Most firms must register with the state in which they intend to conduct business. If you’re forming a corporation, partnership, or limited liability company, you’ll need to register with your state by filing an application.
After you register, your state(s) will typically notify you about which taxes you must pay. You may also find out the taxes you owe by visiting the state’s website or contacting the department directly.
If your state requires you to pay franchise taxes, you must usually do so to the state taxation agency once a year. The mechanism for paying franchise taxes varies by state.
Depending on the state, due dates also may differ. Check with your state to find out your franchise tax deadline and how to make payments.
Final Thoughts
State-level franchise taxes factor in your company’s net worth, charging you based on your share of investments in that state. It may be challenging to stay on top of the rules and regulations in each state where you do business, but neglecting to do so could result in severe consequences for your company. You be fined or lose your ability to operate legally in a state.
To ensure that your firm remains tax compliant, you can consult an accounting firm.
