Practical SALT Guidance: Last week I received an e-mail from a business associate. He's a member of a high-technology finance executive group which includes
CFOs, finance VPs, and corporate controllers, many whom work
for high-tech start-ups. Along with his e-mail, he forwarded a fellow
member's question on state franchise taxes. The question stated that this
executive's company was incorporated in Delaware, had operations in Alabama,
California, and Missouri, and a single employee working in Tennessee.
My colleague, being well aware of my state tax focus,
forwarded the question to me, and I enthusiastically answered it.
I'm often asked about state franchise taxes; many companies
don't understand exactly what a state franchise tax is and when a filing is required.
As the executive who posed the question said, "In most small
start-ups, you need a whole tax department to keep up with the reporting
requirements if the letter of the law were followed in each instance, which
isn't practical for many small companies." And like this executive
you're probably grappled with whether your company is subject to a state's
franchise tax.
But what exactly is a state franchise tax?
Should your company be filing franchise tax returns?
Despite its name, a franchise tax is not a
tax on franchisees. A franchise tax is a business tax imposed for the privilege
of doing business in a state. Currently, about half the states impose
a franchise tax, either in conjunction with, or in lieu of, an income tax.
Being incorporated in or meeting a state's definition of
"doing business" in a state will generally require a franchise tax
filing. In tax-speak, we say that a taxpayer's activities in a state have
created "nexus" for franchise tax purposes. While having an
obvious physical presence in a state, such as owning or leasing a physical
location or having employees who perform their job responsibilities in the
state, would certainly create franchise tax nexus, some less obvious activities
could also be construed as "doing business". Hiring independent
contractors to fulfill a contract or perform a service, having in-state spot
inventory for the convenience of customers even if the bulk of an order is
filled from out of state, soliciting sales even if the solicitation is by
independent sales representatives or agents, or entering a state to purchase,
place or display advertising are all examples of activities that could be
considered "doing business" for franchise tax purposes.
A franchise tax filing may be due even if a company has yet
to begin any activity in a state if the company has filed for a Certificate of
Authority with the Secretary of State. (Yet another, separate filing requirement.)
And although what constitutes "doing business" for franchise tax purposes can vary from state to state, as a general rule, if a company has sales tax nexus (is required to charge and remit sales tax), the company should be filing a franchise tax return. Finally, while it seems almost certain that even minimal activity will create a franchise tax filing responsibility, because the franchise tax is based on an "apportioned" capital, net worth or other non-income base, the amount of franchise tax that might ultimately be due could be nominal.
And although what constitutes "doing business" for franchise tax purposes can vary from state to state, as a general rule, if a company has sales tax nexus (is required to charge and remit sales tax), the company should be filing a franchise tax return. Finally, while it seems almost certain that even minimal activity will create a franchise tax filing responsibility, because the franchise tax is based on an "apportioned" capital, net worth or other non-income base, the amount of franchise tax that might ultimately be due could be nominal.
Oh, and the question posed by the technology executive?
Well, as you probably guessed, I advised him that the company had a
franchise tax obligation in all five states.
Final Comments and Additional Resources:
Interested in a more in-depth discussion on state tax nexus?
Here's link to "Navigating Nexus", an article
published in the November 2011 issue of the Journal of Accountancy. In this
article, my co-author and I discuss nexus for all types of business taxes and
provide a road map for addressing nexus concerns.
A state's franchise tax is generally administered by a
State's Department of Revenue or Taxation. For more information about
your particular state's franchise tax filing requirements, visit your state's
website. You can link to your state's revenue agency website by visiting
the Federation of Tax Administrators state tax agency webpage.
In some states, the franchise tax is imposed only on
corporations, while in other states several types of legal entities may be
subject to the franchise tax. For example, the Texas franchise tax is
imposed on virtually all types of legal entities, including Subchapter C and S
corporations, partnerships, Limited Liability Companies, trusts, professional associations,
etc. Be sure to check whether your entity needs to file.
Finally, though I've provided a quick overview on this
oft-overlooked business tax, state taxes can be complex! So, as I always say,
be sure to consult your CPA, tax advisor, or state tax consultant.
_______________________________________________________________
The above post, "The State Franchise Tax: Another Business Tax to Consider", was authored by Sylvia F. Dion,
and also appeared in the June 23, 2011 issue of the Business Tax Advisor
blog of AllBusiness.com (see side bar for more about her AllBusiness.com
posts.) It has been expanded upon and reproduced as a State and Local Tax "Buzz"
post for the benefit of the "Buzz's" readers.
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