Franchise Tax Definition

A franchise tax is a cost you must pay to do business or exist in a state. Only certain states impose a franchise tax, and some businesses are exempt from it. Let’s take a look at the franchise tax definition. 

What is a franchise tax?

You might think that a franchise tax is some special tax for franchises like McDonald’s or 7-Eleven. Instead, the definition of franchise tax is a tax paid by certain businesses for the right to operate or form in a particular state. It’s also known as a privilege tax, transaction privilege tax, or commercial activity tax. 

Franchise taxes are separate from federal and state income taxes. In fact, this tax has nothing to do with your business income level. The amount of money you make doesn’t affect your obligation to pay the franchise tax, but it might impact how much you owe. 

Which states have a franchise tax?

State agencies impose the franchise tax. Currently, the following 24 states levy a franchise tax on businesses: 

• Alabama
• Arizona
• Arkansas 
• California
• Connecticut 
• DC
• Delaware 
• Florida
• Georgia 
• Idaho
• Louisiana
• Minnesota
• Mississippi
• Nebraska
• New Hampshire
• New Mexico
• New York
• North Carolina
• Ohio
• Oklahoma
• Oregon
• Tennessee  
• Texas
• Wisconsin

Hawaii, Iowa, Maine, South Dakota, Vermont, and Virginia also have a franchise tax, but it only applies to financial institutions. In Maryland, public utility companies are the only businesses subject to the franchise tax.

What businesses pay franchise taxes?

Not every business owes a franchise tax, but this varies by state. In general, businesses that are officially formed by registering with the state must pay a franchise tax. For example, C Corporations, S Corporations, limited liability companies (LLCs), limited partnerships (LPs), and limited liability partnerships (LLPs) must register with the state and pay a franchise tax. These businesses owe franchise tax in their home state, and any other state they’re doing business in that has a franchise tax. So if you do business in multiple states, you may have to pay multiple franchise taxes.

Foreign entities, which are businesses registered in a different state, also often pay franchise taxes. 

Sole proprietorships, general partnerships (GPs), and non-profit organizations are often exempt from franchise taxes. Failing to pay a state’s franchise tax comes with serious penalties, like hefty fines or even losing the right to conduct business in the state. So you need to check with the state to know for sure whether you’re required to pay franchise taxes or not.

How are franchise taxes calculated?

Each state has its own regulations in place for calculating franchise tax. Some have a graduated tax rate that coincides with the size of the business or its net income. Other states use a flat rate that applies regardless of the business’s income. In general, the tax is due annually—but always check with the state’s tax agency. Regardless of how the tax is calculated, the franchise tax benefits the state you’re paying it to you.

Summary

It can go by a different name, but the franchise tax meaning is the same: it’s a payment for the privilege of using the state’s resources to run your business. The franchise tax benefits the state you’re paying it to and is just another price you pay to be an entrepreneur. When you form a business, be sure to find out what the franchise tax requirements are in your state and any other state where you’re conducting business. 

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