What Is Franchise Tax?

Franchise tax is a tax levied at the state level on companies and partnerships that operate in that state. Only companies pay franchise taxes. What companies owe is based on their complete income minus what they pay in compensation to staff or for purchasing packaged or processed items. The distinction between income and these prices is called the margin, which is why the tax is frequently called the “margin tax." The most important Texas tax paid solely by companies, the franchise tax had been the second-largest supply of state tax income, after the state gross sales tax. In 2015, the Texas Legislature diminished the franchise tax charge by one fourth, resulting in a more than $1 billion drop in annual state revenue.

In some states, business with operations in that state may also be charged for the tax even when they're chartered in another state.

Breaking Down Franchise Tax

The amount of franchise tax in a state can differ significantly based on the tax guidelines in that state. Some states will calculate the amount of franchise tax owed primarily based on property or net worth of the enterprise, whereas other states examine the stock of the corporation.

How Businesses Pay Franchise Taxes

Almost every state has some tax on business income. There are some states that only tax corporations and there are some states that will tax almost all business entities. These taxes can go by several different names and meanings. For instance, a franchise tax is the name California gives to this tax.

It’s important to understand that sole proprietorships aren’t typically subject to a franchise tax or other business taxes because they are not usually registered in the state in which they operate.

Local Franchise Taxes and Fees

Local franchise taxes or fees are a legislatively mandated method of compensating cities for the use of public rights-of-way by telecommunications providers.

Local franchise tax is also known as local license fee, state communications service tax, franchise fee, franchise tax, or business and occupation tax.

Understanding the Franchise Tax

A “privilege” tax is another word used to describe franchise tax. This concept means that businesses are being taxed for the right to do business within that state.

There are some states that impose a privilege tax and an income tax. Interestingly enough, West Virginia, and other states, are trying to increase business growth by eliminating franchise taxes altogether.

Which States Have Franchise Taxes?

As it stands, the states that currently impose a franchise tax on their businesses include:

  • Alabama
  • Arkansas
  • Delaware
  • Georgia
  • Illinois
  • Louisiana
  • Mississippi
  • Missouri
  • New York
  • North Carolina
  • Oklahoma
  • Pennsylvania
  • Tennessee
  • Texas
  • West Virginia

How States Define Franchise Taxes

Every state above has a unique process for defining the franchise tax and the businesses that must pay them. They may also have different tax rates and basis for the tax.

Some of the standards for determining franchise tax include: revenue, stock value, company value, asset value, investment made, or gross receipts.

Examples of Franchise Tax Computation

Texas doesn’t have a franchise tax on sole proprietorships even though they do on almost every other business classification. Texas uses margin, or adjusted revenue, to determine its franchise tax. California is another state that imposes a franchise tax on its businesses. It uses a Franchise Tax Board to control the process. Louisiana has franchise and income taxes that businesses or taxable entities must pay.

How Do You Pay Franchise Taxes in Your State?

Many companies (besides sole proprietors) will need to file or register in the state in which they operate. After registering, you will be contacted by your state. You can even verify your franchise tax process and other relevant tax information for your business by contacting your state department or local officials.

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