Franchise Tax: Definition, Rates, Board, Payment By State – Texas, California, Delaware Etc
What is a franchise tax? This article will be focus on taxation, with specific interest on franchise tax and what it means. It will be covering areas such as the type of businesses required to pay this form of taxation and whether it is only meant for franchises.
Although brief, it seeks to as much as possible reveal the most important aspects of this taxation system and if it is national or restricted to specific states. It is hoped that the reader will be educated regarding this type of taxation system.
What is Franchise Tax?
This is a levy charge by a state franchise tax board or government at state level on businesses operating within its geographical territory usually on a yearly basis. These taxed businesses may include Limited Liability Company’s (LLC’s), Corporations and or partnerships.
However, the name franchise attached to this tax does not necessarily mean it is a tax charged on franchises. This tax is usually called “privileged” due to the benefit it derives from conducting its business from within a state.
What is the Implication of Franchise Tax to Businesses?
Since a franchise tax is a levy imposed on businesses operating with a state’s geographical territory, it means that for corporations and other forms of businesses that have their operations spread across several states, they may end up having to pay multiple levies due to their multiple locations, of course depending on whether the state they operate all have this taxation system in place.
The basic criteria used for the determining if a business is qualified to be included in this taxation system is its physical presence within the geographical territory of the state. Physical presence includes having offices or any form of physical equipment within the given territory of a state.
However, this had generated controversy especially in the US Supreme Court ruling involving the state of North Dakota vs. Quill.
Quill Corporation had no physical presence in the state of North Dakota. However, its products which included licensed computer software used for inventory checking of quills’ products and for placement of direct orders from within the state of North Dakota.
This led to an imposition of this tax on Quill, leading to a legal battle all the way to the Supreme Court. The case was ruled in Quill’s favour because they had no physical presence within North Dakota.
Franchise Tax Active States
The franchise tax is not active in all the states within the US. However, there are currently 15 states that this tax is active in and these include; West Virginia, New York, Oklahoma, Pennsylvania, North Carolina, Mississippi, Louisiana, Delaware, Illinois, Georgia, Alabama, Arkansas, Texas, Tennessee and Missouri.
These are the states with active franchise tax laws and businesses such as Corporations, and partnerships must pay this tax for benefiting from operations within its territory.
Negative Aspects to Franchise Tax
Although beneficial to these states in the form of revenue generation, these tax laws stifle the operations of businesses especially in situations where apart from paying the franchise tax, an income tax is also required to be paid by these businesses.
This has created a situation of double taxation where taxation policies are not streamlined for easy facilitation of business transactions. Some states however have started dropping the franchise tax rates, embracing a single taxation for businesses.
Procedures for Payment of Franchise Tax
How does businesses pay franchise taxes? Except for sole proprietorships, all businesses operating with states requiring the payment of franchise tax have to first register with the type of business in view (That is, either Corporation, LLC’s or Partnerships).
There are available franchise tax board application forms for all the business types. After completing the registration procedure, the state will contact the business for commencement of taxation.
Is this Tax Meant for Franchises?
This tax is in no way meant for franchises. The name “franchise tax” does not mean that franchises are taxed, but it only taxes a business with operation within a state, in this case, a single entity.
This business is taxed once, whereas, several franchises using the same brand name, say “McDonalds” operate within the geographical boundary of a state. If it were meant for franchises, then all the franchises with a state will be taxed, leading to a contradiction of taxation of a single business entity.
So long as franchising is concerned, the McDonalds example is a single business entity.
Economic Presence Test
There is a twist to this as it directly contradicts the Quill vs. the state of North Dakota Supreme Court ruling. Whereas the ruling states that businesses must have physical presence within a state’s geographical boundary, the economic test requires that businesses that derive economic benefit from within a state’s geographical boundary either through sales or otherwise must be taxed
The protection from personal liability is the defining characteristics of qualifications for franchise taxation. Because that is the very definition of how Corporations, Partnerships and Limited Liability Company’s LLC’s operate. They are qualified for taxation on this basis as owners are shielded from liability unlike sole proprietorships.
The examples given above are franchise tax components defining its operations, how they are totally unrelated to any form of taxation of franchises and also, an example of disputes involving a Corporation (Quill) and the State of North Dakota.