Understanding franchise tax: Key insights for 2025

Less than half of small business owners (48%) feel confident they’re paying taxes correctly, according to this recent QuickBooks study. This lack of certainty highlights the complexities of tax obligations, including franchise taxes—state-level levies that apply regardless of your business’s profitability.

Franchise taxes are different from income taxes because they’re based on your business’s presence and value within a state, not profits. These taxes ensure that businesses contribute to the states where they operate, helping fund public services and infrastructure. 

In this post, we’ll explain what franchise tax is, how it differs from income tax, and who must pay it. We’ll also cover how it’s calculated and which states require it.

• Who must pay franchise tax?
• How franchise tax works
• Understanding franchise tax calculations
• States that require franchise tax
• Franchise tax vs. state income tax
• Why franchise tax matters for small businesses
• Franchise tax scenarios
• Find peace of mind during tax time
• Franchise tax FAQ

Who must pay franchise tax?

Businesses operating in certain states or chartered there must pay franchise tax. Your obligations depend on your business structure and the states where you operate your franchise.

Types of businesses subject to franchise tax

Franchise taxes are paid by various types of business entities that are registered to operate within a state. These taxes typically apply to businesses that benefit from the legal and regulatory framework of the state.

Franchise taxes apply to many business entities, including:

• C corporations
• S corporations 
• Limited liability companies (LLCs)
• Partnerships 

Franchise taxes are usually charged to businesses registered in a state because they operate under that state's laws. Some companies, like nonprofits, unincorporated businesses, or those from other states, may be exempt from these taxes.

Nonprofits

Some states require nonprofits to pay franchise tax, but they often qualify for exemptions if they meet specific criteria.

Unincorporated businesses

Sole proprietorships are generally exempt from franchise taxes. However, there are exceptions. For example, in some states, even unincorporated entities might owe franchise tax if they operate under a trade name or have sufficient nexus with the state. 

Out-of-state businesses

Businesses that are not physically located in the state but conduct significant transactions there may also be required to pay franchise tax under economic nexus rules. It’s crucial to check your state’s specific requirements to determine if your business type is subject to franchise tax.

How franchise tax works

Franchise tax is tied to a business’s nexus—its connection to a state. States define nexus differently, so knowing the types of nexus is essential. Nexus refers to the connection between your business and a state that justifies taxation. A business may establish nexus through physical presence, economic activity, or other criteria. 

• Physical presence nexus: Having offices, employees, or property in the state establishes physical nexus.
• Economic presence nexus: Some states define nexus based on revenue thresholds or transaction volumes, even if you lack a physical presence.

Understanding franchise tax calculations

Franchise tax calculations vary significantly across states, with each adopting a method that reflects the business’s size, revenue, assets, or other factors. 

Understanding these calculation methods is crucial for small business owners to avoid unexpected liabilities and ensure compliance. These taxes can have a substantial impact on cash flow, especially as a business grows, so it’s important to know how your state calculates its franchise tax and how you can plan accordingly.

Common calculation methods

States use different approaches to calculate franchise taxes, depending on factors like business size, revenue, or assets. These methods ensure that businesses contribute to state tax systems in proportion to their financial capacity.

• Percentage of Net Worth: Some states calculate franchise taxes as a fixed percentage of your business’s net worth. In states like Tennessee and Texas, businesses with a higher net worth pay more. For example, a business with $500,000 in net worth and a 0.1% tax rate would owe $500.
• Value of Capital Stock or Property In-State: States like Texas and Delaware base taxes on the value of a business’s assets within the state. For instance, if your business holds $2 million in assets, taxes may be assessed based on that amount, resulting in a higher liability for businesses with significant in-state property.
• Flat Fees or Sliding Scale: States such as California charge a flat fee, while others like North Carolina use a sliding scale, where tax rates increase with revenue or business size. For example, a business with $100,000 in revenue would pay a lower fee than one with $500,000.
• Authorized Share Method: Some states, particularly Delaware, calculate taxes based on the number of authorized shares, regardless of how many are issued. Companies with more authorized shares may face higher taxes, even if the shares aren’t issued.
• Assumed Par Value Capital Method: Delaware uses this method, which calculates taxes based on the total assumed par value of authorized shares. The tax is applied to the assumed par value capital, providing a more accurate reflection of a business’s financial standing than the Authorized Share Method.
• Gross Receipts Method: Some states, such as Ohio, calculate franchise taxes based on the gross receipts or revenue of a business, regardless of profit. This method is often used for small businesses and can result in a tax burden proportional to a company’s sales volume.
• Capital Method: In states like Georgia, franchise tax is calculated based on the total capital invested in the business. This method considers factors such as equity and debt financing, and businesses may be taxed on their capital in proportion to the amount invested in the company.
• Combination Method: Some states, such as Arkansas and North Carolina, use a combination of multiple methods (e.g., net worth and revenue) to calculate franchise tax. This can help ensure a more balanced and fair approach for businesses of varying sizes and industries.

Minimum and maximum thresholds

In addition to calculating franchise taxes, many states establish minimum and maximum thresholds that apply regardless of a business’s actual profits or size. These thresholds can help small business owners plan for predictable costs and avoid surprises.

• Minimum tax: Several states require businesses to pay a minimum franchise tax, regardless of profitability. California, for instance, imposes a flat $800 minimum tax, even if a business makes no profit. 

This ensures that every business operating within the state contributes to the tax system, regardless of its financial performance. It’s important for small businesses to budget for these fixed costs, as they apply even in tough financial years.

• Maximum tax: On the other hand, some states, like Delaware, set a cap on the maximum amount of franchise tax a large corporation can owe. Delaware’s franchise tax for corporations is capped at $250,000, which benefits larger businesses by limiting their tax burden once they reach a certain revenue threshold. 

Understanding these caps can help businesses with high revenue or net worth plan their finances and avoid overestimating their potential tax liabilities.

States that require franchise tax

Franchise tax rules and rates vary across the US, with some states imposing this tax on a wide range of business entities while others target specific structures or activities. 

States imposing franchise tax

Here’s a breakdown of states levying franchise taxes and key highlights from each.

1. Alabama: Imposes a Business Privilege Tax calculated based on net worth, adjusted by an apportionment factor. Detailed financial data is required for filing.
2. Arkansas: Franchise tax applies to most registered businesses. Rates and filing instructions are provided on the state's website.
3. California: Known for its $800 minimum franchise tax, which applies to all corporations and LLCs registered or operating in the state. Additional calculations may apply based on revenue.
4. Delaware: Charges a franchise tax on corporations based on authorized shares or assumed par value. LLCs and LPs pay a separate annual tax instead.
5. Georgia: Levies a net worth tax in addition to corporate income tax, calculated based on total assets.
6. Louisiana: Applies franchise tax based on capital employed within the state, with additional rules for corporations.
7. Mississippi: Combines franchise tax with corporate income tax filings based on capital employed or property value.
8. Nebraska: Requires corporations to pay an occupation tax based on capital stock or in-state property.
9. New York: Franchise tax is filed alongside corporate income tax, applying to both domestic and foreign corporations conducting business in the state.
10. North Carolina: Part of corporate income tax filings, calculated on net worth or property value within the state.
11. South Carolina: Combines a corporate license fee with franchise tax as part of income tax filings.
12. Tennessee: Charges franchise tax based on the greater of net worth or tangible property value, often filed with an excise tax.
13. Texas: Known for its “margin tax,” calculated on a business’s revenue minus deductions. Businesses must file even if no tax is due.
14. Wisconsin: Applies franchise tax or corporate income tax, depending on circumstances. Foreign corporations must report capital representation.
15. Wyoming: Although not explicitly labeled a franchise tax, an annual report license tax is assessed on total assets in the state.

Get to know the specific franchise tax requirements for your state(s), to better manage your tax obligations and make informed decisions about your business structure and operations.

Notable changes and exemptions

Franchise tax rules can vary significantly across states, with some introducing changes or exemptions that impact business owners. It's important to stay informed about the latest updates to ensure compliance and optimize tax savings.

Illinois: Once slated for elimination, Illinois’ franchise tax remains in effect despite initial plans to phase it out entirely by 2024. Introduced in 2019, the phaseout began with incremental exemption increases. However, the FY 2022 budget halted the phaseout, freezing the exemption at $1000. Subsequent adjustments raised the exemption to $5000, and a proposal aims to increase it further to $10,000.

Oklahoma: Phased out its franchise tax in 2024, with final returns submitted earlier that year.

Texas exemptions: Small businesses with revenue below specific thresholds may qualify for “no tax due” filings, though reporting is still required.

Nonprofit exemptions: Many states exempt nonprofits or allow them to qualify for reduced rates if certain criteria are met.

Franchise tax vs. state income tax

Franchise taxes and state income taxes are distinct but may overlap.

• Income tax: based on profits, only owed if your business earns income
• Franchise tax: owed regardless of income, focused on presence or value

Some states require businesses to pay both franchise and income taxes, which typically happens when the taxes are calculated on different bases. For example, franchise taxes might apply to revenue, assets, or net worth, while income taxes are based on profits. 

In Texas, for instance, a corporation may owe franchise tax on revenue and state income tax if operating in another state that imposes it. Understanding these distinctions helps businesses plan for all their tax obligations effectively.

Why franchise tax matters for small businesses

Stay compliant

Every state has unique franchise tax rules that can impact your bottom line. Understanding these requirements helps you avoid penalties, unexpected bills, and disruptions to your operations.

Budget for the impact

Franchise taxes vary by state—some charge a flat fee, while others calculate taxes based on revenue, net worth, or assets. As your business grows, so can your tax liability. Planning ahead ensures steady cash flow and minimizes surprises.

Simplify the process

Start by identifying where you need to file and review state-specific guidelines. Online tools and state-provided worksheets can help with estimates, but for complex situations, consult a tax professional. Proactive planning keeps you focused on growing your business.

Franchise tax scenarios

Navigating franchise taxes can be tricky, especially since every state has its own rules and calculation methods. 

We’ve chosen these examples from states with particularly complex or unique tax systems to show how businesses in different situations can address their challenges. 

By understanding these scenarios, you can plan smarter and avoid costly mistakes:

Delaware franchise tax for corporations

In this example, a tech startup incorporated in Delaware received a $75,000 tax bill calculated using the Authorized Shares Method. After digging into the state’s tax rules, the business discovered the Assumed Par Value Capital Method. By switching to this calculation, it reduced its liability to just $400. Understanding how taxes are calculated saved the company tens of thousands of dollars.

• Lesson: Know your state’s calculation options.

Delaware gives businesses multiple methods to calculate franchise taxes, but many companies default to the one that’s easiest to understand. Taking time to explore your options—or hiring a tax professional who knows the specifics—can uncover huge savings. This is especially important for startups or growing businesses looking to preserve cash.

Texas margin tax for LLCs

In this example, a mid-sized LLC in Texas was overwhelmed by the franchise tax, which is based on a business’s margin. Initially, the company didn’t realize it could choose between deduction methods. By working with an accountant to use the cost of goods sold (COGS) deduction, the LLC saved thousands of dollars every year. This change helped free up cash for reinvestment.

• Lesson: Deduction strategies matter.

Texas allows businesses to reduce their taxable margin through deductions like COGS, employee compensation, or a standard percentage. Choosing the right deduction for your business can make a significant impact on your tax bill. Regularly reviewing your options with a tax advisor ensures you’re not leaving money on the table.

Multistate nexus issues for retailer

In this example, an e-commerce retailer operating in multiple states didn’t realize it had tax obligations due to economic nexus. When the company received a notice about unpaid taxes, it conducted a nexus study. By correcting its filings and remitting past-due taxes, the retailer avoided penalties and gained a clearer picture of its obligations moving forward.

• Lesson: Monitor nexus rules for multistate compliance.

Each state defines nexus differently, often including thresholds for sales or transactions. If your business operates across state lines, staying on top of these rules is crucial. Conduct regular reviews of where you have economic activity, and consider using software or hiring an advisor to help you track your compliance.

California minimum franchise tax for small businesses

In this example, a single-owner LLC in California paid the $800 minimum franchise tax annually, even though the business wasn’t turning a profit. After consulting with a tax advisor, the owner restructured the business as a sole proprietorship. This change eliminated the franchise tax and simplified tax filing for future years, saving both time and money.

• Lesson: Choose your structure carefully

The right business structure can significantly affect your tax obligations. If you’re a small business or just starting out, review your options before registering. Structures like LLCs offer legal protections but often come with added costs. Consulting a tax professional early on ensures you’re not overpaying while still meeting your goals.

Find peace of mind during tax time

Navigating franchise taxes can feel overwhelming, but it doesn’t have to be. By understanding your state’s specific rules and planning ahead, you can avoid surprises and stay in control. The more proactive you are, the easier it will be to manage your obligations and keep your business on track.

Partnering with a tax professional can simplify the process and ensure you don’t miss any key details. They can help you optimize your filings, identify savings opportunities, and stay compliant across multiple states. Taking this step not only saves time but also reduces stress during tax season.

Don’t let franchise taxes become a source of worry. Explore our tax solutions today to streamline your filings, stay organized, and focus on growing your business with confidence.