Franchise Tax Guide: Definition, FAQs, & More

When it comes to business taxes, it can be tricky to know what you should be doing and when you should be doing it. Today, we’re breaking down the basics of franchise tax, how it works, and why it’s so important for your business operations.

What Is Franchise Tax?

Franchise tax stands as a distinct obligation, differing fundamentally from income tax. States levy this tax on businesses for the privilege of operating, incorporating, or maintaining a legal entity within their jurisdiction.

It’s important to understand that this type of tax is not contingent upon business profits or the level of activity within a state. Even in instances of a business incurring losses, franchise tax obligations may still apply.

Business entities such as limited liability companies (LLCs), partnerships, and corporations are the typical subjects of franchise tax.

The methods used in calculating the tax, the tax rates, and the stipulated due dates for payment can vary significantly across states. Notably, Delaware and Texas are recognized for their specific franchise tax mandates.

Franchise Tax vs. State Income Tax

While franchise tax is a charge for the privilege of doing business in a state, state income tax is a tax on the income generated by a business within a state’s borders.

In essence, franchise tax is more about the existence and operation of the business entity, whereas state income tax concerns itself with the profitability of the business.

Some states administer both franchise tax and state income tax, while others may impose only one of them. For instance, Texas imposes a state franchise tax but does not levy a state income tax on individual net income.

Conversely, a state like California enforces both franchise tax and state income tax. It is worth noting that the franchise tax rate and income tax rate in a given state are generally set at different percentages.

As a business owner, it’s your responsibility to ensure compliance with both of these taxes where applicable. Navigating these obligations can be tough, particularly when you’re operating across multiple states. Mosey helps you keep your business compliant by organizing all of your compliance needs in one platform.

Who Pays a Franchise Tax?

Franchise tax is a requisite for a variety of business entities, and each state has its distinct regulations determining which businesses are obligated to pay it.

The spectrum of entities required to pay franchise tax ranges from C corporations to S corporations, partnerships, and limited liability companies (LLCs). Understanding who is liable to pay franchise tax is crucial, as it forms an integral part of your business’s tax obligations.

Predominantly, C corporations find themselves subject to corporate franchise tax. However, this does not exclude other forms of business entities — S corporations, partnerships, and LLCs are also required to pay franchise tax in several states.

The responsibility to pay franchise tax is not limited to incorporated businesses, as certain states have specific taxes applicable to unincorporated businesses as well. “When choosing to franchise a business, knowing the tax liability is very important. Help from Mosey in staying on track with your tax liability is crucial for the success of your business,” highlights Taylor Fike, Partner at Fike Advisors and Expert Contributor for Mosey.

Are There Franchise Tax Exemptions?

It is essential to note that some states may offer exemptions to specific types of business entities based on the nature of their operations. For instance, small farming businesses that are incorporated may enjoy an exemption in some states.

These exemptions highlight the importance of being thoroughly acquainted with the franchise tax regulations in the states where your business has a nexus.

As of 2021, a total of 18 states, along with the District of Columbia, impose some form of franchise tax on businesses operating within their jurisdictions.

The list includes:

Alabama
Arkansas
California
Delaware
Illinois
Louisiana
Mississippi
Missouri
Minnesota
New Mexico
New York
North Carolina
Oklahoma
Tennessee
Texas
Utah
Wisconsin
Washington, D.C.

Understanding when franchise tax is due, how franchise tax is calculated, and how to file franchise tax returns are integral components of managing your business’s tax obligations efficiently.

The franchise tax board in each state provides resources and guidelines to assist businesses in navigating these processes. Given the complexity and variance in regulations across states, leveraging a tool like Mosey can simplify these processes, ensuring that your business remains compliant and well-informed.

Do All States Have a Franchise Tax?

Franchise tax, while prevalent, is not a universal requirement across all states in the United States. The obligation to pay this tax and the criteria surrounding it vary significantly from one state to another, making it a crucial aspect for businesses to pay attention to, especially when operating across multiple jurisdictions.

Not every state imposes a franchise tax on businesses. The criteria for this tax, including its rate, calculation method, and applicability, are determined at the state level, leading to a diverse landscape of tax obligations for businesses operating in different regions.

A tax nexus plays a critical role in determining a business’s franchise tax obligations. Essentially, a tax nexus is a connection or link between a business and a state sufficient enough to establish taxability.

This can include factors such as having a physical presence, employees, or significant sales in the state. As businesses expand their operations, especially across state lines, understanding and managing tax nexuses become vital to ensure compliance and avoid potential legal pitfalls.

How Is Franchise Tax Calculated?

Franchise tax calculation is a complex process that varies significantly from state to state, with each jurisdiction imposing its own rules and formulas. Understanding these differences and being aware of the potential minimum and maximum limits set by different states is crucial for businesses to ensure accurate tax reporting and compliance.

Every state has its own unique method for calculating franchise tax, and it’s vital for businesses to be familiar with the specific requirements of each state in which they operate.

Common methods include:

Percentage of Net Worth: Some states calculate franchise tax based on a percentage of the business’s net worth.
Percentage of Property Value: The tax may be based on a percentage of the book value of the business’s real or personal property located within the state.
Percentage of Capital Stock: In certain jurisdictions, franchise tax is calculated as a percentage of the value of the business’s capital stock.
Flat Fee: Some states impose a flat fee for all businesses subject to the franchise tax, regardless of size or income.

Many states set minimum and maximum limits for franchise tax to ensure that small businesses are not disproportionately affected and to cap the liability of larger corporations. These limits help create a more equitable tax system but can also add an additional layer of complexity to the tax calculation process.

To provide a concrete example, let’s consider a hypothetical business operating in Texas, a state known for its franchise tax:

Suppose the business has a total revenue of $1.2 million.
Texas calculates franchise tax based on a percentage of the taxable margin or a flat rate, with a minimum tax due of $1,000.
If we assume a taxable margin of 10% and a tax rate of 0.375% (applicable to retailers and wholesalers), the franchise tax due would be $1,200 x 10% x 0.375% = $450.
However, since the tax due is below the minimum of $1,000, the business would pay the minimum franchise tax amount.

This example illustrates the importance of understanding the specific calculation methods and minimum and maximum limits set by each state to accurately determine franchise tax liability.

When Is Franchise Tax Due?

The timely payment of franchise taxes is crucial for businesses to maintain good standing in the states where they operate. A clear understanding of due dates is essential to avoid late penalties and ensure compliance with state regulations. Fike notes that “Having these types of expenses estimated and budgeted for by your business is essential for the long-term success of your company.”

Annual franchise tax reports are typically due after the end of the fiscal year.

What Is the Franchise Tax Board?

The Franchise Tax Board plays a crucial role in tax administration, specifically in the collection of franchise taxes in certain regions, each with its unique set of rules and regulations.

While in states like Texas, the Comptroller’s Office oversees franchise tax collections, describing it as “a privilege tax imposed on each taxable entity,” in California, there’s a specialized Franchise Tax Board dedicated to this task.

This ensures the proper application and enforcement of tax laws, acting as an intermediary between taxpayers and the state’s financial obligations.

Why Did I Get a Refund From the Franchise Tax Board?

Taxpayers sometimes notice discrepancies in their refund amounts, which could be the result of changes made to their tax returns by the Franchise Tax Board. When such modifications occur, the taxpayer will receive a Notice of Tax Return Change detailing the alterations and presenting the updated refund amount.

Some common reasons for adjustments include:

A mismatch between reported withholdings or payments and the records of the Franchise Tax Board.
The taxpayer does not meet the requirements for certain tax credits.
The refund has been redirected to cover past tax debts.

The Franchise Tax Board may also get involved when an individual has outstanding debts with a government agency, working in collaboration to recover the owed amount. This can impact the taxpayer’s refund, reducing the amount they receive.

Why Did I Get a 1099 Misc From the Franchise Tax Board?

Specifically, for the state of California, individuals who received a payment of $600 or more from the California Middle-Class Tax Refund (MCTR) in 2022 were issued a 1099-MISC form. However, this policy was amended in 2023, with recipients of MCTR payments of $600 or more no longer receiving a 1099-MISC.

How To File Franchise Tax

Filing franchise tax can be a complex process, depending on the state and the specific regulations in place. However, understanding the general steps can help streamline the process.

Determine Your Tax Liability

Before you can file, you need to understand if your business entity is subject to franchise tax in the state where you operate. This varies by state and can depend on the type of business you run.

Calculate Your Franchise Tax

Use the appropriate calculation method as per the state’s guidelines. This could be a percentage of net worth, capital stock, real or personal property within the state, or it might be a flat fee.

Gather Necessary Documentation

Compile all necessary financial documents, including balance sheets, income statements, and other relevant financial records.

Complete the Required Forms

Obtain the necessary forms from your state’s Department of Revenue or franchise tax board. Fill them out accurately, ensuring all information is correct to the best of your knowledge.

Submit Your Payment

If franchise tax is owed, ensure that you submit your payment by the due date to avoid penalties and interest. Some states may allow online payments, while others may require a check or money order.

Finally, maintain copies of your filed forms and any payment confirmations. This is crucial for your records and can be invaluable in the case of an audit.

Simplify Franchise Taxes With Mosey

With Mosey, staying ahead of compliance changes has never been easier. Our business compliance platform provides timely alerts and monitoring, a complete calendar of compliance deadlines, weekly reports, and notifications for legislative changes in all 50 states, plus DC, and local tax jurisdictions.

Ready to streamline your franchise tax process and ensure compliance across all states with Mosey? Schedule a consultation with our team to get started.