What is a Franchise Tax?

A franchise tax is a state-level tax that is levied against businesses and partnerships that establish a presence in that particular state. Some state governments charge a franchise tax to businesses that are chartered in that state even if it has no physical locations present. A franchise tax is also known as a privilege tax because it gives businesses the right to operate in that state. The amount of tax liability due to a franchise tax varies greatly from one state to the next. In some states, franchise tax is based on the net worth and assets of the business. Other states consider the company's capital stock value when imposing a franchise tax.

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How to Choose a State to Lower Your Tax Liabilities

‍When you incorporate your business or form a Limited Liability Corporation (LLC), you must select a state jurisdiction to officially form your entity. You are not required to have a physical business presence or to operate your business in that state. Delaware and Nevada are popular choices due to low levels of taxation and laws that are friendly to the operation of a business. Other company owners prefer to incorporate in the state where they live or plan to conduct the majority of their business.

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You should consider the following pros and cons when deciding where to incorporate your business:

• It is less complicated to incorporate or form a LLC in the state where you are physically located. If you register in Delaware or Nevada, you may be required to request permission in the state where you actually conduct most of your business. You may also be required to pay franchise taxes in two different states, even though other costs may be lower.
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• If you plan to do business in more than one state, you must form your business in a single state and then qualify to do business in other states. You can expect to be charged a franchise tax by each state government where your company is registered.

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Annual Report Requirements

‍Most state governments require businesses to submit an annual report in addition to collecting franchise tax. A smaller percentage of states require a report to be filed every other year. One of the primary reasons for state governments to require an annual or biennial report is to collect revenue. Another reason is for the state to keep tabs on changes to the business, such as moving to a new location or a change in ownership.

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Most state governments require the following type of information on annual or biennial reports:

• The principal address of the business as well as the names and addresses of officers and directors for corporations or managers and members for a LLC.
• The amount of stock the company has issued since the last report.
• A fee that typically ranges from $50 to $400.
• A recap of business highlights since the last report.

You are responsible for researching the franchise fee and annual report requirements for each state where you plan to conduct business.