Franchise Tax: Definition & Overview

KEY TAKEAWAYS

• A franchise tax is a levy that is paid by certain enterprises that want to conduct business in some states.
• The franchise tax is not a tax that is imposed only on a franchise, contrary to what the name implies.
• Any franchise taxes paid are in addition to state and federal income taxes.
• The amount of tax can differ depending on the tax rules in the state the organization is operating in.

What Is a Franchise Tax?

A franchise tax is a tax that is paid by certain enterprises that are looking to do business in some states. This tax gives businesses the right to operate in that state. Franchise tax is usually imposed on companies that are incorporated in other states than the one they’re operating in. For example, if your company is incorporated in the state of Washington, but you are also required to register the business in Oklahoma, you will be liable for franchise tax in Oklahoma. 

Despite the name lending to the confusion, a franchise tax isn’t actually a tax on just franchises. It is separate from state and federal income taxes that have to be filed annually. 

A franchise tax is also commonly known as a privilege tax.

Franchise Tax Rates

The amount of franchise tax can differ depending on what tax rules are in place within each state. Some states will calculate the amount of franchise tax owed based on the entity’s net worth or assets. While some other states will base it on the value of the company’s capital stock. Other states charge a flat fee to all businesses that are operating in their jurisdiction. Some other states also calculate the tax rate on the company’s gross receipts.

Filing Franchise Tax

Franchise taxes don’t replace any state or federal income taxes, so it’s not classed as income tax. These are levies that are paid in addition to the standard income taxation. 

The filing of a franchise tax is no different from filing any other type of tax. They are normally paid on an annual basis at either a date set by the state or with their annual renewal of their business registration.

Entities Subject to Franchise Tax

The entities that are subject to the franchise tax can vary slightly from state to state. However, here are the entities that are commonly included: 

• Banks
• Business Associations
• Corporations
• Joint Ventures
• Limited Liability Companies (LLCs), Including Series LLCs
• Partnerships (General, Limited, and Limited Liability)
• Professional Associations
• Professional Corporations
• Savings And Loan Associations
• S Corporations
• State Limited Banking Associations
• Trusts

Entities Not Subject to Franchise Tax

In a similar vein to the entities that are subject to the tax, the entities that are not subject can vary from state to state. Here are some of the entities that again are commonly included: 

• A Nonprofit Self-Insurance Trust Created Under Insurance Code Chapter 2212
• A Trust Qualified Under Internal Revenue Code Section 401(A)
• A Trust Exempt Under Internal Revenue Code Section 501(C)(9)
• Specific Grantor Trusts, Estates Of Natural Persons, and Escrows
• Specific Unincorporated Passive Entities
• Entities Exempt Under Tax Code Chapter 171, Subchapter B
• General Partnerships When Direct Ownership Is Composed Entirely Of Natural Persons (Except For Limited Liability Partnerships)
• Real Estate Mortgage Investment Conduits And Certain Qualified Real Estate Investment Trusts
• Sole Proprietorships (Except For Single Member LLCs)
• Unincorporated Political Committees.

Calculation of the Franchise Tax

Each state will have a slightly different method when it comes to calculated franchise taxes. As an example, we’ll use Texas’ method of calculating franchise taxes. The state levies taxes on all entities that do business within their jurisdiction. They require these businesses to file an Annual Franchise Tax Report every year by the deadline of May 15th. The state then calculates the franchise tax based on the company’s taxable margin, which is derived by taking 70% of revenue and deducting the cost of goods sold and compensation and a $1 mil revenue deduction. The apportionment factor (gross receipts sourced from Texas versus total gross receipt) is taken into consideration. The tax rate depends on the type of business. For example, it is 0.375% for retail and wholesale businesses and 0.75% for all other ones. 

Corporate revenue or gross receipts can be calculated by taking the amount of revenue that is reported on a corporation’s federal income tax return and subtracting statutory exclusions.

Summary

Franchise taxes are paid by certain enterprises that are looking to do business within the jurisdiction of some states. Also known as a privilege tax, it gives the business in question the right to be chartered or to operate within their chosen state jurisdiction. 

If you are looking to figure out your franchise taxes, make sure you check what your chosen state’s tax rules are. As these vary from state to state.

Written by Sandra Habiger, CPA

Sandra Habiger is a Chartered Professional Accountant with a Bachelor’s Degree in Business Administration from the University of Washington. Sandra’s areas of focus include advising real estate agents, brokers, and investors. She supports small businesses in growing to their first six figures and beyond. Alongside her accounting practice, Sandra is a Money and Life Coach for women in business.

Written by Sandra Habiger, CPA

Sandra Habiger is a Chartered Professional Accountant with a Bachelor’s Degree in Business Administration from the University of Washington. Sandra’s areas of focus include advising real estate agents, brokers, and investors. She supports small businesses in growing to their first six figures and beyond. Alongside her accounting practice, Sandra is a Money and Life Coach for women in business.