Building Your Business Business Taxes How Businesses Pay Franchise Taxes By Jean Murray Jean Murray Facebook Twitter Jean Murray, MBA, Ph.D., is an experienced business writer and teacher who has been writing for The Balance on U.S. business law and taxes since 2008. She has taught accounting, business law, and business finance at business and professional schools for over 35 years, has authored several books on saving money and simplifying your business, and was the owner of startup-focused company Emence Enterprises, LLC. learn about our editorial policies Updated on October 22, 2020 In This Article View All In This Article What is a Franchise Tax? Franchise Taxes are a State Tax Franchises Based on Nexus Franchise Tax vs. Income Taxes Which States Have Franchise Taxes Photo: Siri Stafford/ Stone/ Getty Images Many U.S. states have taxes on business income, in various forms. Some states tax only corporations, while others tax most business types. States call these taxes different things, and meanings get confused. One of these taxes is a franchise tax. Learn what it is, which states have it, and how it affects your business. What is a Franchise Tax? A franchise tax is charged by a state to businesses for the privilege of incorporating or doing business in that state. Franchise taxes, like income taxes, are usually imposed annually. Failure to pay franchise taxes can result in a business becoming disqualified from doing business in a state. . Note A franchise tax is not a tax on franchises. That is, it's not a way to tax all the McDonald's franchises in a state. Franchise Taxes are a State Tax The U.S. government doesn't impose franchise taxes on businesses; they are a state tax. Franchise taxes can be different in each state. In California, for example, franchise taxes, under the state Franchise Tax Board, are basically income taxes, paid by individuals and businesses each year. Any business that is required to register with a state, including corporations, partnerships, and LLCs, may be charged a franchise tax. Sole proprietorships are not usually subject to franchise taxes and other forms of state business income tax, because these businesses are not formally registered with the state in which they do business. Franchises Based on Nexus Franchise taxes are imposed on companies that do business in a state; this is the concept of nexus. Determining nexus is complicated and can be based on factors including whether or not the business: Sells goods or services in the stateHas employees in the stateHas a physical location in the state Tax nexus is also different for sales taxes as opposed to income taxes and franchise taxes. Sales tax nexus defines the level of connection between a sales tax jurisdiction and a business. Franchise or income tax nexus is defined by business type combined with whether the entity is doing business in that state, which is defined differently for each state. A business may do business in several states (depending on how the state views the business). Usually, the business is formally registered in one or multiple states. If your business is formally registered in several states or does business in multiple states, you will probably have to pay franchise taxes in each of them. Franchise Taxes vs. Business Income Taxes Franchise taxes may be based on income or a flat amount, depending on the state and type of business. All businesses pay income taxes. but only corporations pay income taxes directly. These income taxes are based on the profit of the corporation. Corporations may pay both federal income tax and state income tax if the state has an income tax. Some states require businesses to pay both income tax and franchise tax. Note Illinois, for example, requires businesses to pay income taxes and an annual franchise tax. Franchise Taxes vs. Annual Reports or Biennial Reports Some states have an annual report that businesses are required to file. This report also comes with a fee. Florida, for example, has an annual report, as does Delaware. Other states, like Iowa, have a biennial (every other year) report that must be filed every other year. Franchise Taxes vs. Gross Receipts Tax A gross receipts tax is a tax on sales. It's not taxing the customer but taxing the seller. It's similar to a franchise tax, but it taxes a different way. Why Franchise Taxes May Not Be Good for Business A franchise tax is what's called a "privilege" tax, meaning that it is imposed on entities for the privilege of doing business in the state. States that have both franchise tax and income tax makes the effective tax rate in these states higher, and it may have the effect of driving business from the state. Which States Have Franchise Taxes The states that currently have franchise taxes are: AlabamaArkansasDelawareGeorgiaIllinoisLouisianaMississippiMissouriNew YorkNorth CarolinaOklahomaPennsylvaniaTennesseeTexas Some states have eliminated franchise taxes, including: Kansas Missouri Pennsylvania (capital stock/foreign franchise tax) West Virginia How States Determine Franchise Taxes Each state has different criteria for determining what type of business entities must pay franchise taxes, the basis for the tax (either income or capital), and the tax rate. States base franchise taxes on differing criteria. Each of these descriptions is defined specifically by the state in which they apply. Always check the tax laws in the state or states where you do business do understand your obligations. Franchise taxes can be based on: Income (thus, the franchise tax is really an income tax) Value of stock, shares of stock, capital stock, or authorized shares Gross assets Flat amount, or an amount up to a certain amount of assets Tangible property or assets (not including intangible assets) Taxable capital (as defined by the state) Paid-in capital Net worth Assessed value of real and tangible personal property or net investment in tangible personal property Gross receipts (this tax is really a gross receipts tax) How Do I Pay Franchise Taxes in My State? Most businesses (except sole proprietors) must register with the state in which they will be doing business. If you are starting a corporation, partnership, or LLC, you register by filing an application for that specific business type. Your state will contact you after you have registered your business and generally notify you of what taxes you must calculate and pay. You can also check with your state's department of revenue to determine whether your state has a franchise tax or another annual tax on businesses. The information contained in this article is not tax or legal advice and is not a substitute for such advice. State and federal laws change frequently, and the information in this article may not reflect your own state’s laws or the most recent changes to the law. For current tax or legal advice, please consult with an accountant or an attorney. Was this page helpful? Thanks for your feedback! Tell us why! Other Submit Sources The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts within our articles. Read our editorial process to learn more about how we fact-check and keep our content accurate, reliable, and trustworthy. Texas Comptroller. "Franchise Tax." Accessed Oct. 6, 2020. Sales Tax Institute. "What is Nexus?" Accessed Oct. 6, 2020.