Franchise tax is a yearly fee some states charge businesses for the right to operate there
A franchise tax is an annual tax that certain states impose on businesses incorporated or registered to do business within their borders. It is not a tax on profit or income — it is a fee for the privilege of operating as a legal entity in that state. The amount you owe depends on the state, the type of business structure you have, and sometimes your revenue or net worth.
Not all states charge franchise tax. As of now, about 20 states impose some form of franchise tax, though the rules, rates, and which businesses must pay vary widely. A business might owe franchise tax in multiple states if it operates in more than one.
Franchise tax is separate from federal income tax, state income tax, and sales tax. You may owe all of them, or only some, depending on your situation and location.
Key Takeaways
- Franchise tax is charged by individual states, not the federal government, and only applies if you operate in a state that has one.
- The tax is based on your right to do business in that state, not on how much profit you made, though some states calculate it using revenue or net worth.
- Corporations, limited liability companies (LLCs), and partnerships may all owe franchise tax, but sole proprietorships typically do not.
- You usually pay franchise tax by filing a return with the state's tax authority and paying the amount due by a set important date, often in the spring.
- Franchise tax is deductible as a business expense on your federal tax return.
Which states charge franchise tax and how much it costs
States that impose franchise tax include Alabama, Arkansas, Delaware, Georgia, Illinois, Kansas, Kentucky, Louisiana, Mississippi, Missouri, New York, North Carolina, Oklahoma, Pennsylvania, Tennessee, Texas, and West Virginia. Some of these states charge a flat fee; others calculate the tax based on your business revenue, net worth, or the number of shares issued. The amount can range from under $100 per year to several thousand dollars.
Delaware, for example, charges an annual franchise tax on corporations and LLCs, with the amount depending on the number of authorized shares or the gross income of the business. Texas imposes a franchise tax (called the Margin Tax) on businesses with revenue above a certain threshold. New York charges an annual filing fee for corporations and LLCs that varies by business type and income level.
Because rates and rules change and vary by state, you should check with your state's department of revenue or secretary of state to find out whether you owe franchise tax and how much.
Who has to pay franchise tax
Franchise tax applies to businesses that are registered or incorporated in a state that charges it. This typically includes corporations, limited liability companies (LLCs), limited partnerships, and general partnerships. Sole proprietorships and single-member LLCs taxed as sole proprietorships are usually exempt.
If you operate in a state other than the one where you are incorporated, you may owe franchise tax in both states. For example, a Delaware corporation that does business in New York may owe franchise tax to both Delaware and New York. The rules for when you must register in another state vary, but generally you trigger the requirement when you have a physical presence, employees, or regular business activity there.
Some states exempt certain types of businesses, such as nonprofits, financial institutions, or insurance companies. Others have a revenue threshold below which you do not owe the tax.
How franchise tax differs from income tax and other business taxes
Franchise tax is not a tax on your profit. Income tax — whether federal or state — is calculated on the money your business earned after expenses. Franchise tax is a flat fee or a fee based on your business structure or size, regardless of whether you made money that year.
This means you can owe franchise tax even if your business lost money or had no revenue. It is a cost of maintaining your legal right to operate in that state, similar to a business license or registration fee.
Sales tax, by contrast, is collected from customers when you sell goods or services and is sent to the state. Payroll tax is withheld from employee wages. Franchise tax is paid directly by the business itself, usually once a year.
When and how to pay franchise tax
Franchise tax is typically due on a set date each year, often in the spring. The exact important date depends on your state and sometimes on your business structure or the month your business was formed. You pay by filing a franchise tax return with your state's department of revenue or secretary of state and submitting the payment.
Some states allow you to pay online through their tax portal. Others require a check or electronic funds transfer. A few states combine the franchise tax return with the annual report your business must file anyway.
If you miss the important date, you may face a penalty and interest charges. Some states will also suspend your business license or corporate status if you do not pay.
Deducting franchise tax on your federal return
Franchise tax paid to a state is deductible as a business expense on your federal income tax return. You report it on Schedule C (for sole proprietors), Schedule E (for rental property), or on the appropriate business tax form for your entity type.
This deduction lowers your taxable income at the federal level, which can reduce the federal income tax you owe. However, it does not reduce the amount of franchise tax itself — you still owe the full amount to the state.
Frequently Asked Questions
Do I owe franchise tax if my business is in one state but I live in another?
It depends on where your business is incorporated or registered. If you incorporated in a state that charges franchise tax, you owe it to that state. If you also do business in another state that charges franchise tax, you may owe it there too. Check both your home state and the state where you do business.
Can I avoid franchise tax by forming my business as a sole proprietorship?
Sole proprietorships are generally exempt from franchise tax. However, if you operate as an LLC or corporation, you will owe it in states that charge it. The choice of business structure should be based on liability protection, taxes, and other factors — not just to avoid franchise tax.
What happens if I do not pay franchise tax?
States typically charge penalties and interest on unpaid franchise tax. Your business license or corporate status may be suspended, which can prevent you from legally operating, signing contracts, or suing in court. You should pay on time or contact your state's tax authority if you cannot.
Is franchise tax the same as a business license fee?
No. A business license fee is a one-time or annual fee to operate a business in a city or county. Franchise tax is a state-level tax on the right to operate as a legal entity. You may owe both, and they are separate payments.
Can I deduct franchise tax on my state income tax return?
Some states allow you to deduct franchise tax on your state income tax return, but not all. Check your state's tax rules. You can always deduct it on your federal return.