Franchise Tax: Definition, Rates, Exemptions, and Example

What is a franchise tax?

A franchise tax is a state-level levy that businesses pay for the privilege of being legally chartered or doing business in a state. Despite the name, it is not a tax on franchising agreements. It is separate from federal and state income taxes and may apply even if a company is incorporated in another state but conducts business within the taxing state.

How it works

• Levied by many—but not all—states; rules and bases vary widely.
• Paid in addition to income taxes, typically on an annual basis.
• States may tax based on measures such as net worth, capital stock, paid-in capital, gross receipts, or a flat fee.
• Multistate businesses can owe franchise tax in each state where they do business or are registered.

Common calculation methods

States use different bases to compute franchise tax, for example:
– Net worth or total assets
– Value of capital stock or paid-in capital
– Gross receipts
– A flat minimum fee
– Special formulas (see the Texas example below)

Examples of rates and rules

• Delaware: Corporate franchise taxes can range from relatively small amounts up to very large annual fees depending on corporation size and filing method; most LLCs and partnerships pay a fixed annual fee.
• California: Applies to S corporations, LLCs, LLPs, and LPs in many cases. Minimum franchise tax for many business entities is $800; S corps may pay the greater of $800 or a percentage of net income.
• Other states differ significantly; always check the specific state agency or comptroller for current rates and filing rules.

Exemptions and relief

Exemptions and reduced rates are commonly available based on:
– Business size (revenue, assets, or employee count): small-business exemptions or thresholds.
– Organizational purpose or structure: nonprofits, fraternal organizations, certain cooperatives, and many governmental entities are often exempt.
– Targeted public-benefit activities: tax incentives or exemptions for renewable energy, manufacturing, R&D, and job-creation initiatives.

Examples of entities commonly exempted (varies by state):
– Nonprofit organizations and charities
– Governmental bodies
– Certain cooperatives and credit unions
– Specific community or conservation corporations

Consequences of nonpayment

• Financial penalties and accruing interest.
• Damage to creditworthiness and business reputation.
• Administrative actions such as suspension or revocation of a business’s good-standing status or license to operate.
• Tax liens or levies that can attach to and lead to seizure of business assets.

Tax planning strategies

• Monitor which states consider you “doing business” and evaluate registration choices to avoid unnecessary exposure.
• Manage asset and capital structures that form the basis of the franchise tax (e.g., financing, inventory, valuation methods).
• Claim applicable exemptions, credits, and deductions—especially credits tied to R&D, job creation, or targeted investments.
• Coordinate entity classification and filing elections (for example, how an LLC elects to be taxed) with franchise tax impact in mind.

Special considerations

• Sole proprietorships typically are not subject to franchise taxes because they are not separate legal entities registered with the state.
• Some states publish long lists of specific organizations that are exempt; check state statutes or the state tax agency for details.
• Multistate businesses should review nexus rules—states define “doing business” differently (sales, employees, physical presence, etc.).

Franchise tax vs. income tax

• Franchise tax: assessed for the right to exist or operate in a state; generally not dependent on profit.
• Income tax: assessed on taxable profits and varies with profitability.
  A business can owe both types of tax concurrently.

Example: Texas margin tax (illustrative)

Texas calculates its franchise tax on a company’s “margin,” with four alternative methods to determine taxable margin:
1. Total revenue × 70%
2. Total revenue − cost of goods sold (COGS)
3. Total revenue − compensation paid
4. Total revenue − $1,000,000
Businesses choose the method that produces the lowest tax liability (subject to state rules). Texas also requires an annual franchise tax report and has specific filing deadlines.

Filing and deadlines

• Deadlines and filing requirements vary by state. Some states set fixed annual dates for corporations and different dates for LLCs/partnerships.
• Penalties for late filing and late payment vary by state and may include fixed fines plus interest.

Bottom line

Franchise taxes are state-imposed charges for the privilege of doing business or being chartered in a state. They differ widely by jurisdiction in measure, rate, exemptions, and filing requirements. Businesses should identify which states have franchise taxes, understand each state’s calculation method, claim applicable exemptions or credits, and integrate franchise-tax considerations into entity-structure and multistate tax planning. Always consult the relevant state tax authority or a tax advisor for specific rules and current rates.