Definition of Franchise Tax
A franchise tax is a tax paid by companies to states, essentially simply to be able to do business in that state. The tax is unrelated to a business' status as a franchise or nonfranchise; a business may be subject to franchise tax no matter its size. Not all states impose a franchise tax; information on whether a state requires franchise tax payment can generally be found on the website of a particular state's Secretary of State or Franchise Tax Office.
States that require payment of franchise tax have different methods of assessing the amount of tax to be paid. Some states require a flat fee upon incorporation. Some states base the franchise tax amount on the number of outstanding shares of corporate stock; some on a company's income or assets. Still other states will assess franchise tax based on a combination of the two criteria above.
Filing Franchise Taxes
States that require a franchise tax vary in the date on which franchise taxes must be filed. Some states set a fixed date for franchise tax filling; others will ask for filing on the anniversary of the company's date of startup or incorporation in-state. Individual states also set their own rules regarding time and manner of franchise tax payments. Some states, such as Delaware, also allow certain corporations to file for exemption from franchise tax requirements. Each state has its own criteria for exemption.
Franchise taxes are subject to the Commerce Clause of the U.S. Constitution, which prohibits state taxation from discriminating against interstate commerce. To avoid violation of the Commerce Clause, a state's franchise tax must also be fairly apportioned and relate substantially to services provided by the taxing state.
Nonpayment of franchise taxes may carry severe consequences. These consequences vary from state to state, but may include monetary penalties based on the amount of franchise tax left unpaid, and suspension or revocation of a company's charter.
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