What is Franchise Tax?

Despite its name, a "franchise tax" is not a tax on McDonalds or other franchises. Instead, it is a tax that states charge on corporations and other business entities, such as limited liability companies ("LLCs"), for the privilege of incorporating or doing business in their state. These taxes are separate from--and owed in addition to--state income taxes that most states impose on corporations and other businesses.

Most, but not all, states impose franchise taxes. Nevada is an example of a state that does not have a franchise tax. In some states, certain types of businesses are fully or partially exempt from the tax. This may include nonprofit corporations, fraternal organizations, and some LLCs. Some states also exempt smaller businesses from the tax.

Franchise tax rates vary widely from state to state. While some states have a single flat-rate franchise tax, others have a graduated rate based on the size of the business or its net income. Some states vary the tax rate based on the type of business entity or business involved.

Franchise taxes must ordinarily be paid annually, often at tax time when other state taxes are paid.

A corporation or other business entity always has to pay the franchise tax in its home state. It may also have pay franchise taxes in other states in which it does business or owns property. Many corporations and other business entities have to pay franchise taxes in multiple states.

If a business fails to pay a state's franchise tax, bad things can happen. For starters, the business will lose the legal right to do business in the state, meaning it won't be able to file lawsuits in the state or enforce its contracts there. It may also be subject to fines and penalties.

When you form a corporation or other business entity, be sure to find out about the franchise tax requirements in your home state and any other states in which you plan to conduct business or own property. Each state has an agency or department within a larger agency that is responsible for collecting franchise taxes. This may be the state controller's office, state taxation department, or something else--for example, in California, this taxing agency is called the Franchise Tax Board.