As the owner of a small business or startup, you may assume that franchise taxes would be the least of your concern. After all, your company is not a giant franchise like McDonald’s. However, this tax is not a tax on franchises and instead just a general business tax for specific enterprises.
Let’s break it down.
What is the Franchise Tax?
State governments place franchise taxes on businesses of all sizes to give said enterprise charter to operate within that state. It is possible to be required to pay franchise tax in a state you don’t operate in but derive a substantial part of your income from.
It is paid alongside income tax, but unlike income tax, it is not predicated on the revenue a business generates. It is also important to note that many states have recently chosen to scrap franchise taxes altogether.
Who Pays the Franchise Tax?
Nonprofits and some limited liability companies are exempted from franchise tax in most states, as are sole proprietorships and general partnerships. Different state governments have different franchise tax rates depending on their need to collect revenue and attract business.
There is no fixed formula for working out the franchise tax an entity owes, as the methodology varies from state to state. Some states compute the tax based on assets the entity owns, while other areas calculate franchise tax based on company capital stock value. Other states simply levy a flat fee on any entity operating within their jurisdictions.
You can expect to pay franchise taxes in the following states: New York, Kansas, Tennessee, Oklahoma, Texas, Louisiana, Illinois, Delaware, Georgia, Alabama, North Carolina, California, Arkansas, and Mississippi. Four states, namely Kansas, Missouri, West Virginia, and Pennsylvania, chose to scrap their franchise taxes at different times between 2011 and 2015.
For example, if your enterprise is headquartered in Kansas but has outlets or employs staff in Tennessee and Oklahoma, will you be required to pay franchise tax in all three states? That will depend on the specific state’s tax rules and whether your company is registered as a business in each state. If your entity is formally registered in all three states, chances are you will need to foot franchise taxes in all those jurisdictions.
Unless your business is registered as a sole proprietorship or partnership where members have been ascertained to be individuals, you will be liable to pay a franchise tax. Some limited liability corporations are exempted from this form of tax. In general, nonprofit organizations and fraternal organizations are not expected to pay a franchise tax. Trusts exempted from taxation under the Internal Revenue Code will also not be required to pay a franchise tax.
Combing through the nitty-gritty of franchise tax can be cumbersome. You may end up factoring in tax expenditure that you shouldn’t be paying. Even if you’re an accountant by profession, you may not be able to dedicate the time to categorize and file your tax obligations correctly. This is where outsourced professional tax accounting services come in handy.
How Is the Franchise Tax Determined?
Different states will have different ways of determining what franchise tax an entity is required to pay. Ordinarily, the computation of franchise tax will factor in the net worth (value of assets minus debt) of the entity, tangible assets, the value of its stock, its gross receipts (revenue without adjustment for expenses), and its income, in some cases. Some jurisdictions simply levy a flat fee as franchise tax for any entity wishing to trade within the state.
If your business is registered in a state that levies franchise tax, you will be liable to pay this for every year you operate there. However, lines become blurry when an entity operates in another state in terms of staff or retail outlets but is not registered there. Whether or not you will be required to pay franchise tax in those states will differ from state to state depending on their tax rules.
Staying on Top of Your Franchise Tax
It is essential to pay as much attention to filing and paying your franchise taxes as with your income tax. Call in the help of trained tax professionals if this process seems to be a little too murky. Besides dodging any attendant penalties, working on your franchise tax with an expert could help you save cash in the event the government discovers this tax doesn’t apply to you.