Many states require businesses to pay franchise tax and file an annual report each year to remain in good standing. Franchise tax requirements vary by state, and not every state imposes the tax. An LLC and a corporation in the same state may also have different franchise tax obligations.
This article explains what franchise tax is, how it is calculated, and how it relates to annual reports.
What is franchise tax for an LLC or corporation?
Franchise tax is a state tax imposed on businesses for the privilege of being organized or registered to transact business in that state. (In some states, this tax is referred to as a privilege tax.) Despite the name, it is not a tax on franchises. States use it mainly to raise revenue, and it is separate from federal and state income taxes. In many states, franchise tax is owed even if the business does not turn a profit.
Each state sets its own rules for which businesses owe the tax. Entities typically subject to franchise tax include corporations, LLCs, limited partnerships (LPs), and limited liability partnerships (LLPs). Some states apply the tax only to certain entities (such as C corporations), and others do not impose a franchise tax at all.
Franchise tax exemptions
Exemptions vary by state, but some types of businesses are commonly excluded. Sole proprietorships are generally not subject to franchise tax, and nonprofit and religious organizations are often exempt. Some states also exempt certain real estate entities, such as qualified real estate investment trusts (REITs) and title holding companies.
Business size is another common factor. Many states exempt small businesses that fall below an asset or revenue threshold, or apply a reduced rate to provide tax relief.
General partnerships may be exempt in some states, but typically only when all of the partners are individuals rather than business entities. Delaware, for example, requires general partnerships to pay an annual tax.
A business should confirm its status with the state before assuming it does not owe the tax. Being exempt from franchise tax also does not necessarily mean a business is exempt from annual report requirements. Many exempt entities, including nonprofit corporations, must still file one.
Franchise tax in other states and for remote sales
A business may owe franchise tax in the state where it was formed, known as its domestic state. It may also owe franchise tax in other states where it is registered to do business or is doing business. A business formed in one state and registered to do business in another is a foreign entity in that other state.
A business does not always need a physical presence, such as an office or employees, to have obligations in another state. Economic nexus is a connection between a business and a state that is based on the volume of business it does there, such as its sales or revenue, rather than on a physical presence. For example, states can require out-of-state sellers to collect sales tax on remote sales into the state.
Some states may also require a business to pay franchise tax without a physical presence. In Texas, for example, an out-of-state entity with $500,000 or more in gross receipts from business in Texas must file a franchise tax report, even if it has no physical presence there. Texas also treats obtaining a use tax permit as a trigger for franchise tax filing requirements.
Thresholds and triggers differ by state and by type of tax, so a business that makes remote sales should check the rules in each state where it sells.
How is franchise tax calculated?
States use different methods to calculate franchise tax. Common methods are based on the following:
- Flat fee. Some states charge a fixed amount each year. The amount may be the same for all businesses or may vary by category, such as entity type or size of the business.
- Gross receipts. Some states charge a percentage of a company’s total revenue before expenses are deducted. For example, if a state charged 0.5% on $300,000 in gross receipts, the franchise tax would be $1,500.
- Net worth, capital stock, or shares. Some states base the tax on a company’s net worth, which is its total assets minus its liabilities, on the value of its capital stock, or on the number of shares it is authorized to issue. These states often set a minimum amount that all businesses must pay.
- Combination of methods. Some states use more than one of these methods to account for differences in business structure and size.
The method can also depend on the type of entity. A state may calculate the tax one way for corporations and another way for LLCs.
Delaware is one example. For corporations, Delaware offers two methods:
- Authorized shares method. The tax is based on the number of shares the corporation is authorized to issue. This is the default method, and the minimum tax is $175.
- Assumed par value capital method. The tax is based on the corporation’s issued shares and total gross assets. A corporation may use this method to recalculate its tax, and the minimum tax is $400.
Under either method, the maximum tax is $200,000. A corporation identified as a large corporate filer is subject to a maximum of $250,000. Delaware assesses the tax if the corporation is active in the records of the Division of Corporations at any time during the tax year, which runs from January 1 through December 31.
Delaware LLCs, limited partnerships, and general partnerships pay a flat annual tax of $400 due June 1, 2027This applies to domestic entities formed in Delaware and to foreign entities registered there.
When is franchise tax due?
Franchise tax due dates vary by state. In many states, the tax is due at the same time as the annual report, although some states set separate deadlines for each.
Some states tie the due date to the anniversary of when the business was formed or registered. For example, if an LLC was formed on February 15, its franchise tax and annual report would be due in February each year. Other states set one due date for all businesses or for each entity type. In Delaware, franchise tax for corporations is due March 1, and the annual tax for LLCs is due June 1. In Texas, franchise tax reports are due May 15.
Because due dates depend on the state and the type of entity, check the requirements for each state where your business is organized or registered.
What happens if you don't pay franchise tax?
Missing a franchise tax payment or filing deadline can lead to financial penalties and, if the problem continues, loss of your business’s good standing with the state. Good standing means the state considers your business compliant and legally authorized to operate. Consequences vary by state, but may include the following:
- Late fees and penalties
- Interest on the unpaid tax
- Loss of good standing
- Suspension, forfeiture, or revocation of the business’s charter or right to do business in the state
- Loss of the ability to sue or defend a lawsuit in court
- Personal liability for officers or directors in some states
The details depend on the state. In Delaware, a corporation that fails to pay franchise tax or file a complete annual report for a year can have its charter declared void. In Texas, a late franchise tax report carries a $50 penalty, even if no tax is due.
Missing an annual report can have similar consequences.
Franchise tax and annual reports
Franchise tax and annual reports are separate requirements, but many businesses handle them together. An annual report is a filing that updates the state’s records on a business, such as its principal address, management, and registered agent. Franchise tax is a payment made to the state for the privilege of being organized or registered there.
Some states collect the franchise tax along with the annual report. Others set separate deadlines or require separate filings.
Completing one requirement does not satisfy the other where the filings are separate, and a business that is exempt from franchise tax may still need to file an annual report.
Some states also require an initial report shortly after a business is formed or registered, which typically comes with a filing fee.
For more on what annual reports include and why states require them, see What is an annual report and how to file one?
Learn more about your state's requirements
Our state incorporation guides outline the annual report, franchise tax, and other requirements for LLCs and corporations in all states. Learn more about annual report due dates by state and entity types.