A franchise tax is a government levy charged by some US states to certain business organizations such as corporations and partnerships with a nexus in the state. A franchise tax is not based on income. The tax calculation is based on the net worth or capital held by the entity.
Payment Schedules and Consequences
For LLCs, the first-year annual franchise tax is due the 15th day of the fourth month from filing with the secretary of state. In later years, it becomes due on the 15th day of the fourth month of your taxable year, generally April 15. If not paid, the owners could lose their limited liability protection.
The tax helps finance infrastructure like education, transportation, and healthcare. The amount varies by state. It applies to almost all business types, except partnerships where ownership is informal.
States define franchise taxes differently. Tax rates and basis (revenue, stock value, company value, etc) vary. But it is not based on profit, so must be paid regardless of annual earnings.
Franchisees pay various fees like start-up and royalties. But franchises are viewed like any small business for tax purposes. So franchise owners must pay income tax and other typical small business taxes.
How Franchise Taxes Work
A franchise tax applies to corporations, partnerships, and many limited liability companies but does not apply to non-profits and some limited liability corporations. It is paid alongside income tax. However, unlike income tax, it is not based on the revenue a business generates. Franchise taxes are also known as privilege taxes.
They allow businesses to be chartered and operate within a state. Rates and basis (revenue, stock value, company value, etc.) vary by state. For example, some states base the tax on gross receipts. So businesses with higher gross receipts pay higher rates.
When calculating franchise taxes, deductions or credits can reduce the amount owed. Failure to pay may result in fines, penalties or revocation of legal operating rights.
Many states have eliminated franchise taxes altogether. Exempted entities include nonprofits, sole proprietorships, general partnerships and some limited liability companies.
Franchise fees paid by new franchise owners allow them to use an established brand. They are amortized over 15 years. So owners can deduct a portion as depreciation each year. This reduces taxable income.
Franchise royalties are ongoing percentage-based fees. These contribute to owners’ gross revenue on which income tax is paid. After income taxes, what remains is the owner’s salary.