The Wacky World of Franchise Taxes

April 6 2017 | by Jason Sneeringer, CPA

Contrary to its name, a franchise tax isn’t something unique to fast food chain owners; its scope is much, much broader. Understanding the rules related to franchise tax is crucial for all business owners. In this blog, we will provide an overview of what is often a confusing topic for businesses with multi-state ties.

What is a Franchise Tax?

Franchise taxes are state based and are the cost a company must pay for the privilege of doing business in a specific state. This tax is not based on the profit of a company, which means even companies that show no profit are sometimes required to pay. To determine whether your business is subject to a state’s corporate franchise tax, you need to understand the concept of “nexus,” which is the legal term for your physical presence in that state.

The Concept of Nexus

One thing you can say about nexus is that it can be confusing. The definition of physical presence in the case of franchise tax is muddy. In this case, a company does not necessarily need a physical presence in a state to qualify. In fact, none of your employees need to set foot in that state to have nexus. If your company sells and ships items to another state or your firm is conducting a service or a project for a client in another state, that may be enough to establish nexus. A good rule of thumb – if you are required to collect sales tax from customers in a state, it’s very likely you have franchise tax nexus.

The confusing nature of nexus is directly related to technology. In today’s marketplace, the advances in technology have removed the geographical boundaries that once existed for businesses. This resulted in states losing valuable tax income and needing to adjust collection requirements to stay ahead. If this makes you question if you are required to pay this tax in multiple states, the answer is yes! There is no limit on the number of states that can impose the franchise tax on your business.

How States Determine Franchise Taxes

If it seemed muddy before, it gets even more so now. Not all states impose a franchise tax, and of those who do, not all of them abide by the same tax rates or criteria for determining the basis for the tax. Some states have a single flat-rate, while others have a graduated rate based on the size of the business or its net income, and there are even some states that vary the rate based on the type of business.

What Happens if I Don’t Pay the Franchise Tax?

Not paying franchise taxes can have a significant and negative impact on your business. Again, not all states have the same structure when it comes to penalties. Some have a flat daily late fee, while others charge a percentage of what you owe, compounded monthly.

In addition to penalties, delinquent payments result in a fallout of good standing with the state. Eventually, your company can be “voided” by the state which means you will not only need to pay the outstanding tax, penalties, and interest, but also need to reinstate your company to do business in the state. It is important to note that a voided company still accumulates tax and penalties.

Next Steps

State taxes can be extremely confusing which often leads to mistakes and unwanted consequences. Watch our on-demand webinar titled Sorting Through the Confusion: The Impact of Income & Franchise Tax, where we will look closely at the complexities of these two tax areas.

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