Dealing with federal income taxes is all part of running a business, but there is another state-level tax that a lot of businesses must pay: franchise tax.
Having nothing to do with owning a franchise, this tax must be paid by many businesses throughout the U.S. simply for operational rights within that state, or the right to even exist within it. Small businesses working with an experienced accounting firm in Coral Gables will be informed about this tax from the get-go, but for those who have yet to come across it, or who are concerned as to whether they must pay it, here is a brief guide:
Franchise tax explained
For the privilege of conducting business within their jurisdiction, some states impose a franchise tax, which may also be referred to as a capital stock tax, or privilege tax. Based on neither income or profits, this tax may be owed by a business, simply for their right to be registered or to operate within that state.
Franchise tax versus income tax
Although with entirely different purposes and calculated differently, these two taxes may both apply to a business within the same tax year.
Franchise tax is linked purely to a businesses existence legally, or operational authority. Whereas income tax is based wholly on profits.
Why is franchise tax charged by some states?
First and foremost, this tax is a source of revenue for a state, but it can also help them keep an accurate record of businesses that are active in the state for regulatory purposes.
Often working alongside yearly franchise tax reports which offer up-to-date information about business ownership, addresses and activity, these requirements can help a state generate revenue while overseeing registered entities.
Who has to pay franchise tax?
Although obligations vary according to each state, this tax typically applies to:
- S Corporations
- C Corporations
- LLCs
- Limited partnerships and limited liability partnerships
And doesn’t usually account for the way at which a business is taxed at federal level.
Multi-state and nexus businesses
If there is a strong enough connection between a state and a business for tax obligations to be imposed, then this is known as nexus. Having a physical office, employees or property are all activities capable of creating nexus in a state.
Multiple state businesses may find themselves with a number of franchise tax liabilities, and having expert guidance from a tax specialist will likely prove helpful.
Calculating franchise tax
With every state setting its own rules for calculating franchise tax, the following bases may be included:
- Total assets or equity
- Net worth or capital stock
- Flat annual fees
- Gross receipts or business margin
Some states, regardless of a business’s revenue size, may impose a minimum tax, while some give the option of choosing a calculation method, and paying the amount that’s lowest.
Requirements for filing and compliance
Requirements for franchise tax filing include:
- Filing of an annual report
- Paying franchise tax by the deadline
- Maintaining a solid standing with the state
A missed deadline or failure to pay franchise taxes, can lead to penalties, interest, or even the loss of a legal right to operate within the state.
Planning for franchise tax
Some strategies that tax services in Coral Gables might discuss with you, include:
- Selecting the most appropriate entity structure
- Carefully evaluating where your business should be formed and registered
- Getting to grips with nexus rules before multi-state expansion
- Annually reviewing franchise tax calculations for accuracy
Selecting the right entity structure is important in terms of franchise tax exposure, and to minimize your liability while ensuing that you’re always compliant with franchise tax (and all other state and federal taxes), working with a small business tax expert is highly recommended.