Some states require certain entities to pay a tax simply for doing business in their state. This is commonly known as a franchise tax. Let’s explore what this tax is, who it applies to, how much it may cost, and more.
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 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. For example, in Delaware, any corporation that is registered in the state must pay a franchise tax, while in Alabama, a company is considered “doing business” in the state simply by owning property in Alabama and is subject to franchise tax.
Who pays franchise taxes?
Not all states have a franchise tax. As of this writing, the following states charge a franchise tax:
- New Hampshire
- New Mexico
- New York
- North Carolina
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 varies significantly by state. For example, Minnesota’s franchise tax applies only to C corporations, but Texas 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, S 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:
- Whether the business has employees in the state;
- Whether the business owns any property in the state; and
- The amount of money generated in the state.
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.
How are franchise taxes calculated?
Franchise tax calculations vary significantly by state. Some states have a flat rate regardless of the business’s income while other states base the franchise tax on net income or the size of the business. Alabama, for example, uses a graduated tax of 0.175% on income over $2.5 million with a cap of $15,000. In Texas, on the other hand, the franchise tax is 0.75% of the business’s taxable margin, which includes revenue less the greater of cost of goods sold, compensation, or 30% of revenue.
Some states provide franchise tax calculators on their websites, so you can calculate your own estimated franchise tax liability.
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.
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.
Franchise Tax FAQ
- 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 is often a percentage of the unpaid tax amount.
- 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.
- Who is exempt from franchise tax?
This varies by state, but often unregistered entity types and non-profit organizations are exempt from franchise taxes.
- Are franchise taxes paid annually?
Generally, businesses pay franchise taxes annually, but consult your state’s tax department website to confirm.