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Editorial 10 MIN READ

The franchise tax is quietly disappearing

In 2019 several states are cutting, phasing out, or repealing the entity-level tax that funded them for a century

The Editors
Staff, Incorporator.org
10 min read Updated
Contents 9 sections
  1. What a franchise tax actually is, in 2019
  2. Delaware: the flat $300 LLC tax and the shares-or-par corporate bill
  3. California: the $800 minimum, unavoidable and contested
  4. Texas: the margin tax with a $1.13 million no-tax-due floor
  5. New York: the capital-base floor that rewards small
  6. Mississippi's phaseout and West Virginia's four-year head start
  7. Illinois runs the other way: the $3,600 personal-property replacement
  8. Where this leaves a 2019 founder
  9. Sources

he state franchise tax, the privilege-of-doing-business levy that most founders first encounter as a surprise bill in year two, is in slow retreat. In 2019 Mississippi is partway through a phaseout, West Virginia has been clean of the tax for four years, and the remaining holdouts are a smaller list than it was a decade ago.

This is a map of where the state-level franchise tax stands as of this fall, what the rates actually are in the states that still impose it, and why the trend is running one direction almost everywhere.

What a franchise tax actually is, in 2019

A franchise tax is not an income tax. It is a tax on the privilege of existing as a chartered entity under state law, or on the privilege of transacting business as a foreign entity qualified in the state. That distinction matters because franchise taxes typically apply whether or not the entity made any money, and whether or not it did anything at all during the year. An LLC registered in Delaware on December 28 owes the full annual tax by June 1 the following year regardless of whether a single invoice went out.

The base varies wildly. Some states tax authorized shares. Some tax net worth. Some tax margin (a Texas invention). Some tax gross receipts. A handful still charge a flat fee that is a franchise tax only in name. The common thread is that the tax is triggered by the entity's legal status rather than its economic result.

This is why the franchise tax tends to lose political support over time. In years with thin margins, founders and small businesses pay the tax anyway. Legislators hear about it. The receipts, meanwhile, are small relative to personal income tax and sales tax in most states. The cost-benefit math bends toward repeal.

Delaware: the flat $300 LLC tax and the shares-or-par corporate bill

Delaware's franchise tax on LLCs and LPs is a flat $300, due June 1 each year, under 6 Del. C. § 18-1107 for LLCs. There is no report attached; you pay the tax, and that is the whole of the annual obligation. Miss the deadline and Delaware adds a $200 penalty plus 1.5% monthly interest on the unpaid balance.

Delaware corporations are a different animal. They owe both an annual report fee and a franchise tax, computed one of two ways under 8 Del. C. § 503. The default method, authorized shares, scales with how many shares the certificate of incorporation authorizes. The alternative, assumed par value capital, scales with gross assets and issued shares. The statutory minimum for a corporation using the assumed-par-value method is $400, and the cap was raised to $200,000 under House Bill 175 in 2017 (for large corporate filers) and held there through 2019, with an even higher $250,000 cap available for "Large Corporate Filers" as defined by statute. A newly formed C-corp with 10 million authorized shares that does the math wrong routinely receives a bill in the tens of thousands of dollars and then recomputes on the par-value method down to the minimum. The notice Delaware mails in January is always printed at the larger of the two numbers, which is how founders find out.

Delaware's position in the national picture is unusual because the franchise tax is a meaningful share of state revenue. In the fiscal year ending June 30, 2019, franchise-tax and abandoned-property collections together accounted for a material chunk of general fund receipts, and the Division of Corporations routinely reports well over a million entities on the rolls. Delaware is not going to repeal its franchise tax. It is the business model.

For a walkthrough of the Delaware mechanics as they sit, see the in-house guide at Delaware LLC formation, 2016. The filing fees have shifted slightly since then; the $300 annual tax has not.

California: the $800 minimum, unavoidable and contested

California has what is, in practical terms, the heaviest minimum franchise tax in the country. Under California Revenue & Taxation Code § 17941, every LLC doing business in California owes an annual tax of $800, due on the 15th day of the fourth month of the taxable year. Corporations owe the same $800 minimum under R&TC § 23153, with a first-year exemption for newly incorporated corporations that no longer extends to LLCs. There is a gross-receipts fee on LLCs layered on top, tiered under R&TC § 17942, running from $900 for total California income of at least $250,000 up to $11,790 for total income of $5 million or more.

The $800 minimum applies to any LLC "doing business" in California, a term the Franchise Tax Board interprets broadly. A Delaware LLC with a California member who manages the LLC from California has, under the FTB's position, a California filing obligation even if the LLC's operations are elsewhere. The leading case, Swart Enterprises, Inc. v. Franchise Tax Board, 7 Cal.App.5th 497 (Cal. Ct. App. 2017), narrowed that position slightly for a purely passive out-of-state investor in a California LLC, but the FTB's aggressive posture on residence and management continues. Out-of-state founders with California ties should assume the tax applies until counsel tells them otherwise.

California is not moving to repeal or reduce the $800 minimum. If anything, the FTB's enforcement posture has sharpened since Swart.

Texas: the margin tax with a $1.13 million no-tax-due floor

Texas replaced its old franchise tax with the margin tax in 2006, and in 2019 the tax applies at 0.375% for retailers and wholesalers and 0.75% for everyone else, computed on the lesser of four margin bases under Tex. Tax Code § 171.101. The headline feature for small businesses is the no-tax-due threshold: for reports originally due January 1 through December 31, 2019, entities with total revenue at or below $1,130,000 owe no tax, per the Texas Comptroller's 2019 thresholds. They still have to file a No Tax Due report and a Public Information Report, and the penalties for not filing are real, but there is no check to write.

The $1.13 million threshold, indexed biennially, is the reason most small Texas LLCs experience the franchise tax as a compliance task rather than a bill. That design (a modest rate with a high exemption floor) is why Texas can keep the margin tax politically durable while Mississippi cannot keep its older, lower-floor version.

New York: the capital-base floor that rewards small

New York's corporate franchise tax, Form CT-3 under N.Y. Tax Law § 210, is computed as the greater of three bases: business income, business capital, or a fixed-dollar minimum tax. For 2019, the fixed-dollar minimum for a general business corporation runs from $25 for corporations with New York receipts of $100,000 or less up to $200,000 for corporations with New York receipts over $1 billion, on a graduated schedule set out in N.Y. Tax Law § 210(1)(d).

The capital base itself, under § 210(1)(b), was scheduled for a long phase-out after the 2014 corporate tax reform, dropping from 0.15% at the start toward full elimination. By 2019 the capital-base rate had fallen close to zero for most general business corporations and was set to hit 0% for tax years beginning on or after January 1, 2021. That phase-out is one of the larger contractions of a franchise-tax base in the country, and it is the quietest.

New York LLCs do not pay the corporate franchise tax; they pay an annual LLC filing fee under N.Y. Tax Law § 658, ranging from $25 to $4,500 depending on gross income sourced to New York. It is not a franchise tax as such, but it functions like one: triggered by existence and residence, not by net income.

Mississippi's phaseout and West Virginia's four-year head start

Mississippi is the 2019 poster child for the trend. House Bill 1601, enacted in 2016, phases out Mississippi's corporate franchise tax over ten years. The tax, historically $2.50 per $1,000 of capital under Miss. Code § 27-13-5, is declining on a statutory schedule: $2.25 per $1,000 for tax years beginning after December 31, 2018; $2.00 per $1,000 for years beginning after December 31, 2019; and stepping down annually until the tax is repealed outright for tax years beginning on or after January 1, 2028. Mississippi is also simultaneously reducing the lowest bracket of its corporate income tax under the same bill.

West Virginia got there first. Senate Bill 190 (2012) phased out the West Virginia Business Franchise Tax, and the tax ceased to apply for tax years beginning on or after January 1, 2015, per W. Va. Code § 11-23. By 2019 the West Virginia franchise tax is a historical footnote; what remains on the books is the Corporation Net Income Tax, which is ordinary income-based.

The pattern in both states is the same. Legislators argued the franchise tax hit capital-intensive and low-margin businesses hardest, that the receipts were modest relative to the compliance burden, and that neighboring states without the tax had an edge for relocations. Those arguments are not unique to Mississippi and West Virginia. Similar bills have been introduced, though not passed, in Alabama, Louisiana, and Tennessee in the last several sessions.

Illinois runs the other way: the $3,600 personal-property replacement

Illinois is the outlier in 2019. The Illinois franchise tax, imposed on corporations under 805 ILCS 5/15.35 and administered by the Secretary of State, is computed on paid-in capital at rates that stack an initial tax plus an annual tax with a $25 minimum. The headline statutory ceiling sounds low, but the effective number for many Illinois corporations is not the Secretary of State franchise tax itself. It is the Personal Property Replacement Tax under 35 ILCS 5/201(c) and 5/201(d), a 2.5% tax on corporate net income (and 1.5% on partnership and S-corp net income) that replaced the old personal-property tax repealed by the 1970 Illinois Constitution.

For a profitable Illinois corporation, the Replacement Tax is the tax that stings, and it runs on top of the 7% Illinois corporate income tax. A small Illinois corporation netting $100,000 pays roughly $2,500 in Replacement Tax on top of regular income tax, and some filings put the typical combined franchise-plus-replacement burden for a mid-sized Illinois corporation in the low-to-mid four figures per year before income tax.

There has been legislative momentum in 2019 to phase out the Secretary of State franchise tax itself. Senate Bill 689 (enacted June 2019) provides for a graduated phase-out of the Illinois franchise tax on paid-in capital, with the tax fully eliminated for reports due on or after January 1, 2024. The Replacement Tax, which is the larger number in most cases, stays. Illinois is therefore a case of reducing the franchise tax in name while leaving the economically similar tax in place.

Where this leaves a 2019 founder

The practical takeaway, if you are forming this year and trying to decide where to register or qualify, is that the franchise-tax landscape is no longer a matter of picking the state with the lowest headline number. It is a matter of matching the tax design to the entity.

A holding company with no operations is cheapest in a flat-fee state: Delaware at $300 a year for an LLC, Wyoming at $60, or a state that has repealed the tax entirely. A small operating business with revenue under a million dollars is untouched by Texas's margin tax, unburdened by Mississippi's declining rate, and out of reach of New York's capital-base phase-out, so the choice of state for that kind of business should turn on sales tax nexus, personal income tax, and qualification fees rather than on the franchise tax. A California business cannot escape the $800 minimum by forming elsewhere, because the FTB will follow the management.

The interesting question for the next five years is whether Mississippi's 2028 repeal will be joined by another state following the same statutory template, or whether states that have been quietly shrinking the base (New York, Illinois on paper) will keep grinding the number toward zero without a dramatic bill. West Virginia's experience suggests that once a franchise tax is gone, the fiscal sky does not fall, which is the argument the reformers in the remaining states will keep making.

Sources

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