Franchise tax is a state-level tax imposed on businesses for the privilege of operating as a corporation or LLC in a particular state, often based on a company's revenue or assets.
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A franchise tax is a cost you must pay to do business or exist in a state. Only certain states impose a franchise tax, and some businesses are exempt from it. Let’s take a look at the franchise tax definition.
A franchise tax is a tax imposed by some states on certain businesses for the “privilege of doing business” or incorporating in their state. For that reason, it’s sometimes called a privilege tax, but some states have other names for it as well, such as a transaction privilege tax or commercial activity tax.
Although the name “franchise tax” implies a special tax imposed only on franchises, like Jiffy Lube or Pizza Hut, that isn’t the case. It’s purely a tax on the right to operate a business in a state that has a franchise tax.
Franchise taxes are separate, and they may be in addition to other taxes like state business income tax. Further, franchise tax isn’t owed based on the amount of income your business makes; rather, you may have to pay it regardless of whether your company makes a profit. Each state has differing franchise tax regulations.
Not all states have a franchise tax. As of this writing, the following states charge a franchise tax:
Some states impose a franchise tax only on certain industries. For example, franchise taxes in Hawaii, Iowa, Maine, South Dakota, Vermont, and Virginia apply only to financial institutions. In Maryland, only public utility companies must pay a franchise tax.
The types of business entities that pay franchise taxes vary significantly by state. For example, Minnesota’s franchise tax applies only to C corporations, but Texas franchise tax imposes its franchise tax on a wider range of businesses, including all partnership types.
Typically, businesses that must register or incorporate with the state pay franchise taxes. This includes C corporations, limited partnerships (LPs), limited liability partnerships (LLPs), and limited liability companies (LLCs).
Foreign entities “doing business” in the state are also typically subject to franchise tax. Foreign entities are businesses registered or incorporated in a different state. To determine a foreign entity’s franchise tax liability, many states look at the nexus between the business’s activities and the state and consider a variety of factors, including:
Since a foreign entity could have a nexus with multiple states, it may have to pay franchise taxes in multiple states.
Figuring out what constitutes “doing business” in a state for an online business can get complicated. While some states provide guidance on their websites, you still may want to consult a professional like a CPA.
Franchise tax isn’t imposed on all business types. Sole proprietorships, general partnerships (GPs), and non-profit organizations are typically exempt. Again, this varies by state, so it’s important to understand your state’s tax laws.
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Not every business owes a franchise tax, but this varies by state. In general, businesses that are officially formed by registering with the state must pay a franchise tax. For example, corporations, LLCs, limited partnerships, and limited liability partnerships must register with the state and pay a franchise tax. These businesses owe franchise tax in their home state and any other state they’re doing business in that has a franchise tax. So, if you do business in multiple states, you may have to pay multiple franchise taxes.
Foreign entities, which are businesses registered in a different state, also often pay franchise taxes.
Sole proprietorships, general partnerships, and non-profit organizations are often exempt from franchise taxes. Failing to pay a state’s franchise tax comes with serious penalties, like hefty fines or even losing the right to conduct business in the state. So, you need to check with the state to know for sure whether you’re required to pay franchise taxes or not.
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Each state has its own regulations in place for calculating franchise tax. Some have a graduated tax rate that coincides with the size of the business or its net income. Other states use a flat rate that applies regardless of the business’s income. In general, the tax is due annually — but always check with the state’s tax agency. Regardless of how the tax is calculated, the franchise tax benefits the state you’re paying it to you.
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It can go by a different name, but the franchise tax meaning is the same: it’s a payment for the privilege of using the state’s resources to run your business. The franchise tax benefits the state you’re paying it to and is just another price you pay to be an entrepreneur. When you form a business, be sure to find out what the franchise tax requirements are in your state and any other state where you’re conducting business.
We’re here to support your small business at all stages of growth. Whether you’re just business formation plans or need help with state compliance requirements, we have a product or service for you. Everything we offer is geared toward helping you create, run, and grow your company. Reach out to us today!
Does an LLC have to pay franchise taxes?
Some states require LLCs to pay a franchise tax, so it’s best to look at your state’s laws.
What happens if you don’t pay franchise tax?
States typically impose penalties and interest for non-payment of franchise taxes, which are often a percentage of the unpaid tax amount.
Who do I pay franchise taxes to?
Typically, your business pays its franchise taxes to the state’s department of revenue, comptroller’s office, or whichever state department governs tax payments. Most tax department websites have portals to register to pay your franchise tax payment online.
What is the difference between a franchise tax and a gross receipts tax?
A franchise tax is a tax solely for the privilege of doing business in another state, and it has nothing to do with whether the business makes money in the state. Gross receipts tax, on the other hand, is tax on a business’s gross sales (regardless of their source) before any deductions are taken, so it depends on the amount of income the business makes.
How often is franchise tax paid?
Generally, franchise taxes are paid annually, but it’s a good idea to consult your state’s laws.
Franchise tax liability varies by state, entity type, and industry. To determine if your business is eligible for this tax, you may want to consult your state tax department’s website. States often want the franchise tax payment along with the business’s annual or biennial filing reports, if required. Failure to meet your state’s deadlines can result in severe penalties. At ZenBusiness, we can help with your annual or biennial report with our annual report service. Our expert staff and automated technology are available to make the filing process seamless.
Who is exempt from franchise tax?
This varies by state, but often unregistered entity types and non-profit organizations are exempt from franchise taxes.
Disclaimer: The content on this page is for information purposes only and does not constitute legal, tax, or accounting advice. If you have specific questions about any of these topics, seek the counsel of a licensed professional.
Written by Team ZenBusiness
ZenBusiness has helped people start, run, and grow over 700,000 dream companies. The editorial team at ZenBusiness has over 20 years of collective small business publishing experience and is composed of business formation experts who are dedicated to empowering and educating entrepreneurs about owning a company.
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