Most states tax at least some types of business income derived from the state. As a rule, the details of how income from a specific business is taxed depend in part on the business’s legal form. In most states corporations are subject to a corporate income tax while income from “pass-through entities,” such as S corporations, limited liability companies (LLCs), partnerships, and sole proprietorships, is subject to a state’s tax on personal income. Tax rates for both corporate income and personal income vary widely among states. Corporate rates, which more often are flat regardless of the amount of income, generally range from 4% to 9%, and personal rates, which generally vary depending on the amount of income, can range from 0% (for small amounts of taxable income) to around 9% or more in some states.
A few states have no corporate income tax, and a few other states have no personal income tax.
Apart from taxing business income through a corporate income tax or a personal income tax, many states impose a separate tax on at least some businesses, sometimes called a “franchise tax” or “privilege tax.” This is frequently defined as a tax simply for the right or “privilege” of doing business in the state. As with state taxes on business income, the specifics of a state’s franchise tax often depend in part on the legal form of the business. Franchise taxes are generally either a flat fee or an amount based on a business’s net worth.
Delaware has a franchise tax and a corporation income tax, as well as a tax on limited liability companies, limited partnerships, and general partnerships. Your business may be subject to one or more of these taxes depending on its legal form. Additionally, if income from your business passes through to you personally, that income will be subject to taxation on your personal state tax return.
Delaware’s franchise tax, which is essentially a tax on the privilege of having a Delaware business, applies to traditional corporations (C corporations) and S corporations. Delaware provides two different methods for calculating the franchise tax: the authorized shares method and the assumed par value capital method.
Authorized Shares Method. Your corporation pays a flat fee that varies depending on the number of authorized shares, as follows:
Assumed Capital Value Method. Your corporation pays a flat fee that varies depending on its amount of assumed no-par capital along with a fee for assumed par value capital. The fees for amounts of assumed no-par capital are as follows:
The tax for assumed par value capital is $350 for each $1 million or fraction thereof of assumed par value capital.
Delaware corporation income tax is assessed at a flat 8.7% of taxable income derived from Delaware. (By comparison, the state’s personal income tax rate varies from 2.2% to 6.75%.)
Delaware LLCs, limited partnerships, and general partnerships are required to pay an annual tax of $250.
Let’s very briefly look at additional details for five of the most common forms of Delaware business: corporations (C corporations), S corporations, LLCs, partnerships, and sole proprietorships.
Corporations. Delaware corporations are subject both to the state’s franchise tax and its corporation income tax.
Example: For the latest tax year, your Delaware corporation had taxable net income of $100,000, has 10,000 authorized shares, assumed no-par capital of $100,000, and assumed par value capital of $100,000. Your corporation will owe Delaware corporate income tax in the amount of $8,700 (8.7% of $100,000). Also, assuming you choose to use the authorized shares method to calculate your franchise tax, your corporation will also owe franchise tax in the amount of $150 ($150 tax for corporations with 5,000 to 10,000 authorized shares).
S Corporations. An S corporation is created by first forming a traditional corporation, and then filing a special form with the IRS to elect “S” status. Unlike a traditional corporation, an S corporation generally is not subject to separate federal income tax. Rather, taxable income from an S corporation is passed through to the individual shareholders, and each shareholder is subject to federal tax on his or her share of that income. In other words, S corporations are “pass-through” entities. (Note that a shareholder’s share of the S corporation’s income need not actually be distributed to the shareholder in order for the shareholder to owe tax on that amount.) Delaware recognizes the federal S election and does not require Delaware S corporations to pay income tax. However, it does require these businesses to the state’s franchise tax. In addition, an individual S corporation shareholder will owe tax to the state on his or her share of the company’s income.
Example: For the latest tax year, your Delaware S corporation had taxable net income of $100,000, 10,000 authorized shares, assumed no par capital of $100,000, and assumed par value capital of $100,000. Your S corporation will owe Delaware franchise tax; assuming you choose to use the authorized shares method to calculate that tax, your corporation will also owe franchise tax in the amount of $150 ($150 tax for corporations with 5,000 to 10,000 authorized shares). In addition, the remaining net income will be allocated to you and your fellow shareholders, and you will each pay tax on your own portions on your respective state tax returns. The rate for each shareholder will vary depending on his or her overall taxable income for the year.
Limited Liability Companies (LLCs). Like S corporations, standard Delaware LLCs are pass-through entities and are not required to pay federal or state income tax. LLCs are, however, required to pay a flat annual tax of $250 to the state. This annual tax aside, income from the business is distributed to individual LLC members, who then pay federal and state taxes on the amounts distributed to them.
Note that while by default LLCs are classified for tax purposes as partnerships (or, for single-member LLCs, “disregarded entities”), it is possible to elect to have your LLC classified as a corporation. In that case, the LLC would also be subject to Delaware’s corporate income tax.
Example: For the latest tax year, your multi-member LLC, which has the default tax classification of partnership, had net income of $100,000. The LLC will owe the state LLC tax of $250. Beyond this, the LLC’s net income will be divvied up between you and your fellow LLC members, and you will each pay tax on your own portions on your respective state tax returns. The rate for each member will vary depending on his or her overall taxable income for the year.
Partnerships. General partnerships and limited partnerships are required to pay a flat annual tax of $250 to the state. However, this annual tax aside, income from partnerships is distributed to the individual partners, who then pay tax on the amount distributed to them on both their federal and state tax returns.
Example: For the latest tax year, your general partnership had net income of $100,000. The LLC will owe the state general partnership tax of $250. Beyond this, the partnership’s net income will be divvied up between you and your fellow partners, and you will each pay tax on your respective portions on your respective state tax returns; the rate for each partner will vary depending on his or her overall taxable income for the year.
Sole Proprietorships. Income from your business will be distributed to you as the sole proprietor, and you will pay tax to the state on that income.
Example: For the latest tax year, your sole proprietorship had net income of $100,000. The $100,000 in net income is distributed to you personally, and you pay tax on that income on your individual state tax return; the rate will vary depending on your overall taxable income for the year.
Note on Multistate Businesses and “Nexus”
Our primary focus here is on businesses operating solely in Delaware. However, if you’re doing business in several states, you should be aware that your business may be considered to have “nexus” with those states, and therefore may be obligated to pay taxes in those states. Also, if your business was formed or is located in another state, but generates income in Delaware, it may be subject to Delaware taxes. The rules for taxation of multistate businesses, including what constitutes nexus with a state for the purpose of various taxes, are complicated. If you run such a business, you should consult with a tax professional.
For further guidance on Delaware’s franchise tax, corporation income tax, and tax on LLCs, general partnerships, and limited partnerships, check the Division of Corporations website. For information on business-related taxes in other states, check Nolo’s 50-State Guide to Business Income Tax. And, if you’re looking for detailed guidance on federal income tax issues, check Tax Savvy for Small Business, by Frederick Daily (Nolo).