Posted by Karen Munoz, EA

Franchise Tax: How Businesses Pay It

Franchise Tax: How Businesses Pay It

The tax that exists on all business income differs in various states. While some US states tax corporations strictly, others tax many forms of businesses. Various states have different meanings for such taxes, and the implication could be confusing.


Understanding Franchise Tax

This is a form of tax levied by states to a business for the purpose of having their presence in such a state. Like income tax, such tax is paid annually and not paying might lead to the disqualification of such business. 

A franchise tax should not be confused with taxes on franchises. For example, it is not the tax levied on all franchises of KFC in the state of the US.


Franchise Taxes and State Taxes 

The federal government does not mandate the government to pay franchise taxes. It is a state tax and differs from state to state. For instance, in California, franchise taxes, handled by the Franchise Tax of the State Board, are taxes paid by businesses every year on their income. 

All businesses in which registration with the state is compulsory will need to pay a franchise tax. This includes all forms of business except sole proprietors, as they are exempted from various forms of business income tax since such business hardly registers with the state.


Comparing Franchise and Income Taxes for Business

Franchise taxes might be a factor of the flat or income amount, depending on the business type and state. 

Income tax is compulsory for all businesses; however, only corporations will have to pay income taxes directly. The income is the value of the corporation’s profit. Corporations might have to pay both state and federal income tax if income tax is compulsory in the state. In some states as well, a business will pay both franchise and income tax.

In Illinois, for instance, a business will typically pay both income taxes as well as the franchise tax annually.


Comparing Franchise Taxes and Gross Receipt Taxes

A gross receipt tax is the tax specified on sales. It is different from a tax on the customer but the seller. It is like a franchise tax even though in the other way.


The disadvantage of Franchise Tax for Businesses

Another name for franchise tax is “privilege” tax which means that businesses will pay them for the privilege of having a business presence in their state. The states that levy both income tax and franchise tax on businesses might drive potential investors from such a state.


States that have Franchise Taxes

Here are states with franchise taxes: Arkansas, Alabama, Georgia, Louisiana, Delaware, New York, Illinois, Oklahoma, Texas, West Virginia, Pennsylvania, Missouri, Tennessee, Oklahoma, North Carolina, etc. Some states have gotten rid of franchise tax like Missouri, Kansas, West Virginia, and Pennsylvania.


How States Estimate their Franchise Taxes

All states have their criteria for estimating the business that should pay franchise tax, alongside the basis for such payment, which could either be capital or income, as well as the rate of tax. 

There are various criteria for franchise tax. Each state defines their standards and descriptions:

  • Income which makes franchise tax an income tax

  • Par value of the stock, the value of the capital stock, shares of stock, or shares authorized

  • Gross assets

  • Paid-in capital

  • Net worth

  • Gross receipts

  • Taxable capital specified by state

  • Tangible properties and assets, excluding intangible assets

  • The estimated value of tangible and real personal property

Setting up for the Payment of Franchise Taxes: How to go about it

Many businesses (excluding sole progenitors) need a registration with the US state where they will have their business. With this, for someone establishing a corporation, LLC, or partnership, you need to file your application for the exact business type to register. The state will make contact with you after registering the business. 

One can also review the state’s revenue department to know if there is a franchise tax in your state or other compulsory taxes on business. 



Karen Munoz, EA
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