Everything You Need To Know About Franchise Taxes
Despite what the term implies, franchise tax has very little – if anything – to do with the franchise business model. Instead, a franchise tax is something which is defined by each state in the U.S. and geared toward corporations as a privilege tax. Understanding franchise taxes and their ramifications is very important for business owners operating within various states, or those entrepreneurs shopping around for a base of operations, and weighing the best franchise tax programs in the United States.
How Does Franchise Tax Work?
When partnerships, LLCs or corporations decide to do business in a particular state, they must pay a franchise tax. A franchise tax is paid in addition to – but not in place of – income tax, and must be posted annually.
This Is Not A Tax On Franchises
A franchise tax is geared toward parent corporations. For instance, is a franchisor wants to open a business in New York, then they must comply with New York State’s franchise tax codes. Franchise taxes are not a means for the state to tax every single franchise operation within New York. Franchise taxes apply to the main corporation. On the other end of the scale, let us look at Coca-Cola. Coca-Cola is a huge corporation based in Georgia. While they do not offer franchises, they do have bottling plants throughout the continental United States. For Coca-Cola to operate their plants in New York, Ohio, Missouri, North Carolina, and elsewhere, they must pay a franchise tax to each of those states.
Franchise Tax Rates Differ Between States
A franchise tax is based on income amount. For instance, a particular state may charge a 4 percent franchise tax on the first $25,000 in revenue from a corporation. After that, the percentage usually scales up directly with revenue. Some states will charge 5 percent on the next $25,000 in revenue, on up to 8 percent on $200,000 and above. When looking to operate in other states, it helps to shop around to see how much they charge in franchise taxes.
Income Is Not The Only Factor In Franchise Tax Rates
As stated above, the criteria for franchise tax rates differ from state to state. While income certainly plays a good part, other states use different factors. Some use the value of stock for public companies as one of the foundation metrics. Others weight the overall net worth of a business. States will also figure in the value of real and tangible property owned by a business in the respective state, and base franchise ta rates off of that number. Finally, some states will also levy a franchise tax on the value of gross receipts. On top of franchise tax codes, it is in the interest of business owners to research how the number is derived.
Calculating Franchise Tax
There is no set formula for franchise taxes. The states the use franchise tax typically have a Franchise Tax Board, or a division of the State Comptroller’s Office to determine exactly how franchise taxes will be calculated. Franchise taxes are generally based on a company’s total revenue, which is adjusted to create a taxable margin. This margin is derived using one of four basic methods: The total annual revenue minus monetary compensation; the total annual revenue minus the cost of goods sold; total revenue minus $1 million; or the total annual revenue times 70 percent.
Not Every State Charges A Franchise Tax
Currently, the only states that levy a franchise tax against corporations are:
- West Virginia
- North Carolina
- New York
It should be noted that many of the above states are in the process of revising, reducing, or eliminating their franchise tax laws completely. The main reason for this is that having a franchise tax in place drives business to other locations. Being known as a “franchise tax free” state promotes business grown, and creates more jobs, as opposed to states that have progressive franchise tax laws that prohibit both business and economic growth.
Some states have both income tax and franchise tax laws. In essence, businesses looking to set up in particular states may find themselves taxed twice for running successful operations. However, a few of these states offer a trade-off with existing resources. Louisiana, for example, has access to the Gulf of Mexico and the Mississippi River; two major shipping channels for manufacturers, importers, and distributors, plus the advantage of being equidistant to both the east coast and California. Similarly, New York is also a point of international trade, with highways and a rail system for transporting goods throughout the country. Franchise tax rates are not the only metric to consider when looking for corporate locations. It helps to look at the available resources in a particular state before dismissing them out of hand due to franchise tax laws.
Which Organizations Pay Franchise Taxes?
With the exception of sole proprietors, most businesses (LLCs, partnerships, etc.) must register in the state in which they are going to operate. Each state has its own application, specific to your corporate structure. After registering, someone from the state offices will contact you or our accounting department to go over any tax requirements, including both income and franchise tax rates. Franchise taxes must be files every year, usually by the same date that business income taxes are due. If you want to get a head start on the process to see how franchise taxes will impact your budget and forecasts, you should check out your state’s Department of Revenue to see what the corporate tax expectations are.
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