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Franchise Tax: Definition & Overview

Updated: November 25, 2022

When an enterprise wants to conduct business in some states, it may have to pay what is known as a franchise tax. This franchise tax is not an income tax, and contrary to the name – it is not a tax on franchises.

So what exactly is a franchise tax? And how do you file and calculate it?

Read on as we take a closer look and answer your questions on franchise taxes.

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    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 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 or to be chartered. Companies in some of these states may also be liable for the tax. This is even if they are chartered in a separate state. 

    Despite the name lending to the confusion, a franchise tax isn’t actually a tax on 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.

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    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 in question’s capital stock.

    Other states can just charge a flat fee to all businesses that are operating in their jurisdiction. Or they would calculate the tax rate on the company’s pain-in capital or 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 the same time that any of a business’ other taxes are due. 

    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
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    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 margin. This is computed using one of these four formulas:

    Franchise Tax Formulas

    Corporate revenue 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.

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    FAQS on Franchise Tax

    What Happens if You Don’t Pay Your Franchise Tax?

    If you don’t pay your taxes, your company could be marked void or administratively canceled by the state.

    Is the Franchise Tax Board the Same as the IRS?

    The IRS is a federal body, whereas the franchise tax board enforces state income tax obligations.

    When Is Franchise Tax Due?

    The date franchise tax is due will depend on which state you are filing it in. Make sure to check in the state’s website for further information.

    Why Am I Being Charged a Franchise Tax?

    A franchise tax is charged for the privilege of incorporating or doing business in your state.

    What Is the Franchise Tax Fee?

    The fee that you are charged from franchise tax will depend on the state regulations. Be sure to check with your state’s tax board to make sure you don’t over or underpay.

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