The annual tax season can be challenging for many businesses, whether you operate a sole proprietorship, partnership, LLC, or corporation. One type of tax you need to be aware of is the franchise tax, which you may need to pay if you are trying to do business in a given state and that state requires this tax.
Each state has its own set of laws about franchise taxes, so it is essential to understand what you’re up against when you’re trying to do business. This is your guide to the franchise tax, including what it is, who pays it, and how your business goes about paying it.
Franchise Tax Defined
Many states require enterprises to pay the franchise tax if they are going to do business in that state. This tax essentially allows them to operate in the state legally. It is important to note that, despite the name, franchise taxes are not taxes on franchises. Partnerships, corporations, and LLCs are generally required to pay this tax if it is a state requirement. Businesses have to pay corporate income taxes each year, which are figured based on the business’s net profit. A company that didn’t make a profit in a year thu has no corporate income tax liability. Franchise taxes, on the other hand, are not figured based on net income. Companies must pay these taxes whether or not they made a profit. Some states have a graduated rate for franchise taxes, and some have a flat rate that eligible businesses pay. The graduated rate will account for factors like the size of the company and net income. Location is always an important factor since state laws vary, so ask a tax attorney about your situation.
Who Pays Franchise Taxes?
Only some businesses and organizations have to pay franchise taxes, depending on the state’s laws. The following types of entities are examples of those that typically do not have to pay these taxes:
Nonprofit Organizations
Community organizations and charities that are registered 501c3 organizations are often exempt from franchise taxes.
Fraternal Organizations
Some social or membership clubs, such as a brotherhood, won’t have to pay the franchise tax.
Some LLCs
All LLCs must pay the franchise tax in some states, but some states allow certain types and sizes of LLCs to be exempt. In Texas, for example, LLCs only have to pay the franchise tax if they have annual revenue of over $1.13 million. Delaware requires all LLCs to pay a flat franchise tax yearly.
Sole Proprietorships
Sole proprietorships may not have to pay franchise taxes because they are often not formally registered as a business with the state in which they’re doing business. Single-member LLCs usually have to pay franchise taxes, however.
Note that certain states also allow very small businesses an exemption from the tax. It is always wise to ask a tax professional about the rules within your state since they vary so widely.
4 Steps to Pay Franchise Taxes
You need to understand what the actual process looks like to cover your bases with franchise taxes. This type of tax needs to be factored into your planning right away, so there are no surprises down the road, especially because you have to pay it whether or not your business earns a profit in a given year. Here are the key four steps to paying your franchise taxes:
1. Understand Your State Laws
First and foremost, learn whether or not the state you want to operate out of requires a franchise tax. These 13 states had a franchise tax in 2020:
- Alabama
- Arkansas
- California
- Delaware
- Georgia
- Illinois
- Louisiana
- Mississippi
- New York
- North Carolina
- Oklahoma
- Tennessee
- Texas
Check within your applicable state to understand if your type of business must pay the tax. A tax professional will also be able to help you determine whether it applies to your company.
2. Calculate Your Tax Rate
You then need to understand what you’ll have to pay. This amount will again depend on your state. Many states require an annual flat fee, so you know what to expect each year, while other states have graduated rates, as mentioned earlier. An S corporation in California, for example, will pay the greater of $800 or 1.5% of its net income, and an LLC could pay from $800 to nearly $12,000.
3. Pay Annually
Franchise taxes are usually paid at the same time your business pays its federal and state income taxes. Remember to factor in this additional tax when making your calculations and planning throughout the year. Franchise taxes are a state tax, and thus each state has its process for making the actual payment. Conduct research or talk to a tax expert to see if your state allows you to pay quickly using an online system.
4. Pay in Multiple States
Doing business out of multiple states may mean you need to pay franchise taxes in each of those states, unfortunately.
Franchise taxes are a part of doing business in some states, and failing to pay these taxes, or paying them past the deadline, will cause your business to incur penalties. Make sure you always take the right steps by working with a tax professional who fully understands your state’s laws.
Contact a Franchise Tax Expert With Questions
Keeping track of changing tax laws is not always easy for business owners. Working with a tax attorney or other tax professional is recommended, so you get expert advice and guidance on the steps you need to take to comply. Silver Tax Group’s experts and tax lawyers will learn about your business situation and advise accordingly. We can help you with tax planning, filing, IRS defense, emergency tax, and tax consulting, among many other services. Our team understands the constantly changing tax laws and how they impact your business. Reach out to Silver Tax Group to speak to a tax expert about franchise taxes and whether your business has to pay this additional levy each year.
