How Businesses Pay Franchise Taxes
Many U.S. states have taxes on business income, in various forms. Some states tax only corporations, while others tax most business type. States call these taxes different things, and meanings get confused. California, for example, calls its income tax a "franchise tax," and Texas uses gross receipts as one way to impose its franchise tax.
Sole proprietorships are not usually subject to franchise taxes and other forms of state business income tax, in part because these businesses are not formally registered with the state in which they do business.
Let's see if we can straighten out this confusion:
What is a Franchise Tax?
A franchise tax is charged by a state to corporations, partnerships, and LLC's for the privilege of incorporating or doing business in that state. Franchise taxes, like income taxes, are usually imposed annually. Failure to pay franchise taxes can result in a business becoming disqualified from doing business in a state.
Franchise taxes are imposed on companies that do business in a state; this is the concept of nexus, or location. Determining nexus is complicated, including whether or not the business sells in the state, has employees in the state, or has a physical location in the state.
A business may do business in several states (depending on how the state views the business), and usually the business is formally registered in the state, or in multiple states. If your business is formally registered in several states, you will may have to pay franchise taxes in several states, if you do business in those states.
What a Franchise Tax is NOT
A franchise tax is not a tax on franchises. That is, it's not a way to tax all the McDonald's franchises in a state.
Why Franchise Taxes May Not Be Good for Business
You'll notice in the definition, I used the word "privilege." A franchise tax is what's called a "privilege" tax, meaning that it is imposed on entities for the privilege of doing business in the state.
Some states (like Louisiana) have both income taxes and franchise taxes. This makes the effective tax rate in these states higher, and it has the effect of driving business from the state.
The Heartland Institute says that franchise taxes are being eliminated in some states (like West Virginia), to encourage business growth.
What States Have Franchise Taxes
The states that currently have franchise taxes are: Alabama, Arkansas, Delaware, Georgia, Illinois, Louisiana, Mississippi, Missouri, New York, North Carolina, Oklahoma, Pennsylvania, Tennessee, Texas, and West Virginia.
How States Determine Franchise Taxes
Each state has different criteria for determining what type of business entities must pay franchise taxes, the basis for the tax (either income or capital), and the tax rate.
States base franchise taxes on differing criteria:
- income (thus, the franchise tax is really an income tax)
- par value of stock, shares of stock, or value of capital stock
- paid-in capital
- net worth
- assess value of real and tangible personal property or net investment in tangible personal property
- gross receipts (this tax is really a gross receipts tax)
The State of Illinois has a chart showing the states that have franchise taxes (as of 2014) and how those taxes are determined.
Some Examples of How Franchise Taxes are Computed by States
Note: These are brief overviews; use the links to go to the state websites for more details.
Texas has a franchise tax on most business entities, but not on sole proprietorships. The tax is based on what the state calls "margin," which is total revenue adjusted in one of 4 ways:
- Total revenue times 70%
- Total revenue minus Cost of Goods Sold
- Total revenue minus compensation, or
- Total revenue minus $1 million.
This article from the Texas Comptroller of Public Accounts has more details.
California has a Franchise Tax Board, and this board administers and collects income taxes from businesses and individual taxpayers.
Louisiana has both income tax and franchise tax on businesses. The income tax and franchise tax are both imposed on corporations, or entities taxed as corporations.
The franchise tax is imposed on "capital employed in Louisiana" and the rate is:
$1.50 for each $1,000 or major fraction thereof up to $300,000 of capital employed in Louisiana, and $3 for each $1,000 or major fraction thereof in excess of $300,000 of capital employed in Louisiana.
How Do I Get Set Up to Pay Franchise Taxes in My State?
Most businesses (except sole proprietors) must register with the state in which they will be doing business. So, if you are starting a corporation, partnership, or LLC, you register by filing an application for that specific business type. Your state will contact you after you have registered your business.
You can Also check with your state department of revenueto determine whether your state has a franchise tax or another annual tax on businesses.