A franchise tax is a fee that some states charge businesses for the right to conduct business within the state. Less than half of all U.S. states levy a franchise tax on businesses like C Corporations and Limited Liability Companies. States that do impose this “privilege tax” have different rates and rules pertaining to it.
Some states exempt certain types of businesses, such as nonprofits from having to pay the tax. And some companies operating within a certain industry that’s considered beneficial, such as renewable energy, may also be exempt.
Also, businesses that are not registered with the state, such as Sole Proprietorships or General Partnerships, generally do not have to pay franchise taxes. In some states, however, a single-member LLC that files as a sole proprietor for tax purposes may have to pay a franchise tax. Be sure to find out exactly what is required in your state.
Let’s take a closer look at what franchise taxes are and how they’re assessed.
More About Franchise Taxes
As you’ve read, franchise taxes are fees that businesses in certain states must pay for the right to conduct business there. Franchise taxes are separate from state and federal income taxes. Many states impose either a state income tax or a franchise tax, but businesses in some states may be required to pay both.
Unlike state and federal income taxes, franchise taxes normally are not based on how much profit a company makes. So, a company may have to pay a franchise tax for the privilege of conducting business in the state, even if it operated at a loss.
How much a business must pay in franchise taxes also depends on the state in which it’s located, as the method of calculating a tax rate varies. Some states have a flat rate, but in other states the rate may be based on a percentage of business assets, gross receipts for the tax year, or a percentage of the net worth of the company.
Deadlines for paying the tax also vary from state to state. Some states set a specific date by which taxes must be paid, but that date can vary depending on the business entity. A Corporation in Delaware, for instance, must pay the franchise tax by March 1 , but an LLC doesn’t have to pay until June 1.
Other states mandate that the tax must be paid on the 15th day of a certain month of the tax year, usually the third or fourth. Still others base the due date on the anniversary of when a business was formed. If you owe franchise tax, be sure to check the due date on your state’s website.
Whether or not a business must pay franchise taxes within a certain state may depend on if the business has nexus there. Having nexus means that the business is connected to the state in some way. A company that does business in multiple states may have nexus in each one and be required to pay a franchise tax in every state that requires it.
Generally, a company is considered to have nexus with a state if it has a physical or an economic presence there:
- A business has a physical presence in a state if it has an office, warehouse, distribution center, or other physical location there, regardless of whether the property is owned or leased. Having employees who reside in a state also can imply physical presence.
- An economic presence is established when a business generates a certain level of economic activity within a state. That level varies, but generally means more than 200 sales transactions or $100,000 in sales within a state in one year. Check with your state to learn its parameters for economic presence.
There’s no common definition of what nexus is or what having it means for a business, and it’s not uncommon for states to change their rules regarding nexus. Business owners must be vigilant in keeping up with any changes to assure they remain in compliance with state laws.
Failure to Pay Franchise Taxes
Like nearly everything pertaining to franchise taxes, the consequences of failing to pay them vary from state to state. Penalties, however, can be significant for businesses.
Businesses that miss the deadline for paying franchise taxes will be charged late fees, which can continue to increase until all taxes and fees are satisfied. Those fees can be hefty and add up quickly. Also, failure to pay franchise taxes can negatively affect a business’s credit rating and make it more difficult to get loans or other financing.
In some cases, a company’s business license could be suspended or revoked, as the business would not remain in good standing if its tax obligations have not been met. In extreme cases, the state could impose tax liens, which could result in property being seized or sold to pay the taxes. If you are unable to pay your franchise taxes, be sure to file for a time extension and consult a tax attorney for advice.
A Final Thought
Franchise taxes can easily be overlooked, as they are paid in addition to other taxes you’re responsible for. Take some time to read carefully about franchise taxes in your state as the guidelines for how the tax is calculated, which businesses must pay it, and when the money must be submitted can be tricky to understand. If you need help, please be sure to contact a qualified professional.
