Franchise taxes are a type of tax levied on corporations by states in the United States. Corporations and similar business entities enjoy certain legal benefits. One is the ability to exist indefinitely until terminated by the desire of the owners, or until declared insolvent and allowed to die. This allows the business of the corporation to persist beyond the lives of those who began the business. It also allows for the accumulation of capital and ownership separate from people who manage the business of the corporation. In this way corporations allow the accumulation of wealth benefited by professional management. Another important benefit of incorporation is that it shields its shareholders from liability for the actions of the corporation beyond the shareholders’ investment in the corporation.
It is beyond the scope of this writing to explore corporations and related entities more fully. Suffice it to say that the price exacted for these benefits of incorporation is that the corporation must be chartered in a sovereign jurisdiction. Each state in the United States has the power to enact laws allowing for the charter of a corporation under its laws. This has created a push-pull competition between the states to attract corporations to be chartered within that state as opposed to another.
Many public corporations have historically been chartered in Delaware because of that state’s aggressive posture at providing benefits and protections to its corporations and shareholders. Many corporations are chartered in Nevada so as to avoid corporate income taxes. And so, the game has gone on and continues to go on.
Corporations pass on the costs of franchise taxes to consumers in the as higher prices for goods and services, which can make it more difficult for lower-income people to afford necessities. This is problematic in the United States, where income and wealth inequality are significant and growing issues.
What are Franchise Taxes?
Franchise taxes are a type of tax that is levied by state governments on businesses that are incorporated or registered to do business within the state. These taxes are separate from federal, state, and local income taxes and are imposed by each state individually.
The specific rules and regulations governing franchise taxes vary between states, but they are typically based on the business’s net worth, capital stock, or other factors related to the business’s size and financial position. For example, some states calculate franchise taxes based on the value of a corporation’s outstanding shares of stock, while others calculate the tax based on a company’s assets or net income.
Franchise taxes are typically paid annually and are used to generate revenue for state governments, which are responsible for providing public services and infrastructure that benefit businesses and the community. These taxes are used to fund a wide range of services, including education, public safety, transportation, and healthcare.
Franchise taxes are separate from federal income taxes and are imposed by each state individually. Therefore, the rules and regulations governing franchise taxes vary significantly between states, and businesses that operate in multiple states may be subject to different franchise tax requirements in each jurisdiction.
The purpose of franchise taxes is to generate revenue for state governments.
How do Franchise Taxes Work?
Franchise taxes are a type of tax that state governments charge on businesses incorporated or registered to do business within the state. The specific rules and regulations governing franchise taxes vary between states, but some general principles apply across most jurisdictions. Here’s how franchise taxes work in the United States:
- What is the Basis for Franchise Taxes?
The basis for franchise taxes varies between states. Still, it is typically based on the business entity’s net worth, capital stock, or other factors related to the business’s size and financial position. For example, some states calculate franchise taxes based on the value of a corporation’s outstanding shares of stock, while others calculate the tax based on a company’s assets or net income.
- Who Pays Franchise Taxes?
Franchise taxes are typically paid by corporations, limited liability companies (LLCs), and other types of businesses that are incorporated or registered to do business within the state. In some cases, businesses that are not incorporated or registered to do business within the state may also be subject to franchise taxes if they have a significant presence within the state.
- When are Franchise Taxes Due?
The due date for franchise taxes varies between states, but it is typically based on the anniversary of the business’s incorporation or registration to do business within the state. For example, some states require franchise taxes to be paid on the first day of the business’s fiscal year, while others require the tax to be paid on the anniversary of the business’s incorporation or registration.
- How is the Amount of Franchise Tax Determined?
The amount of franchise tax owed by a business is typically calculated based on the basis for the tax (such as net worth or capital stock) and the tax rate established by the state. The tax rate for franchise taxes varies between states, and it may be a flat rate or a percentage of the basis for the tax.
- What Happens if a Business Doesn’t Pay Franchise Taxes?
If a business fails to pay franchise taxes on time or in the correct amount, the state may take several actions to collect the tax. This may include imposing penalties and interest on the unpaid tax, seizing assets or property, or revoking the business’s right to do business within the state.
History of Franchise Taxes
Franchise taxes have a long history in the United States, dating back to the early 20th century. Here is a brief overview of the history of franchise taxes in the United States:
- Early 20th Century: In the early 1900s, several states began levying franchise taxes on corporations. These taxes were based on the corporation’s capital stock’s value and were used to fund state government operations.
- Great Depression Era: During the Great Depression of the 1930s, several states increased their franchise tax rates to generate additional revenue. Franchise taxes became an essential source of revenue for state governments during this period.
- Post-World War II Era: In the post-World War II era, franchise taxes continued to be an essential source of revenue for state governments. Many states updated their franchise tax laws during this period to reflect changes in the business landscape, such as the growth of multistate corporations.
- Late 20th and Early 21st Centuries: In recent decades, franchise taxes have remained an important source of revenue for state governments, although the specific rules and regulations governing these taxes vary significantly between states. Some states have updated their franchise tax laws in response to changes in the economy and business practices, such as the growth of online retailers.
Impact of Franchise Taxes
Franchise taxes can significantly impact businesses, particularly small businesses that may have limited resources to cover the costs of these taxes. For example, small businesses may have a relatively low net worth or capital stock but may still be required to pay significant franchise taxes. This can place a significant financial burden on these businesses, making it more difficult for them to grow and succeed.
Franchise taxes can also impact the state’s economy. These taxes are used to fund public services and infrastructure that benefit businesses and individuals alike. For example, franchise taxes may be used to fund the construction and maintenance of roads, bridges, and other infrastructure businesses rely on to transport goods and services. These taxes may also be used to fund public schools, which help to educate the workforce that businesses depend on.
Franchise Tax Disproportionately Impact Lower-Middle Income People
Franchise taxes are a tax that state governments impose on businesses incorporated or registered to do business within the state. These taxes are used to generate revenue for state governments, which are responsible for providing public services and infrastructure that benefit businesses and the community. However, franchise taxes can significantly impact lower-middle-income people, as these individuals may be more likely to work for or rely on small businesses that are subject to franchise taxes. Franchise taxes are virtually invisible to the public and become a significant obstacle for the poor and even the middle class to obtain the business benefits of incorporation.
Impact on Small Businesses
Franchise taxes are a tax levied by state governments on businesses incorporated or registered to do business within the state. These taxes can significantly impact small businesses, which may have limited resources to cover the costs of these taxes. Here are some of the ways that franchise taxes can impact small businesses:
- Financial Burden
Franchise taxes can place a significant financial burden on small businesses. Small businesses may have a relatively low net worth or capital stock but may still be required to pay significant amounts in franchise taxes. This can make it more difficult for small businesses to invest in their operations or to repay loans.
- Difficulty in Growth
Franchise taxes can make it more difficult for small businesses to grow and expand their operations. When businesses are required to pay significant amounts in franchise taxes, they may have less money available to invest in their business or to hire new employees. This can limit the ability of small businesses to expand their operations and create new job opportunities.
- Competitiveness
Franchise taxes can also impact the competitiveness of small businesses. When small businesses are required to pay significant amounts in franchise taxes, they may be less able to compete with larger businesses with more resources. This can make it more difficult for small businesses to survive and succeed in the marketplace.
- Compliance Costs
Small businesses may also incur additional compliance costs associated with franchise taxes. For example, small businesses may need to hire accountants or tax professionals to ensure that they comply with the specific rules and regulations governing franchise taxes in their state. These additional costs can significantly burden small businesses, particularly those with limited resources.
- Availability of Loans
Franchise taxes can impact the availability of loans for small businesses. When businesses are required to pay significant amounts in franchise taxes, they may have less money to invest in their business or repay loans. This can make it more difficult for small businesses to obtain the financing they need to start or expand their operations.
Impact on Employees
Franchise taxes can also impact employees who work for small businesses. When small businesses are required to pay significant amounts in franchise taxes, they may be less able to offer competitive salaries or benefits to their employees. This can make it more difficult for employees to make ends meet or access healthcare, retirement savings, or other benefits critical to their financial security. Here are some of the ways that franchise taxes can impact employees:
- Limited Wage Increases
Franchise taxes can limit the ability of small businesses to increase wages for their employees. When businesses are required to pay significant amounts in franchise taxes, they may have less money available to invest in their operations or to offer competitive salaries to their employees. This can limit the ability of employees to earn higher wages and improve their financial situation.
- Reduced Benefits
Franchise taxes can also impact the availability of benefits for employees. When businesses are required to pay significant amounts in franchise taxes, they may be less able to offer healthcare, retirement savings, or other benefits critical to employees’ financial security. This can make it more difficult for employees to access the resources they need to live healthy and financially stable lives.
- Job Losses
Franchise taxes can also impact the availability of jobs for employees. When businesses are required to pay significant amounts in franchise taxes, they may be less likely to expand their operations or invest in new hires. This can limit the availability of job opportunities for employees who may be seeking work in these industries.
- Limited Job Security
Franchise taxes can also impact the job security of employees. When businesses must pay significant franchise taxes, they may be more likely to lay off employees or reduce their work hours to reduce costs. This can make it more difficult for employees to maintain a stable and consistent income, impacting their financial security and overall well-being.
How Much Revenue Comes from Franchise Taxes?
State governments levy franchise taxes and no federal franchise tax exists in the United States. The revenue generated by franchise taxes varies significantly between states, and no comprehensive data is available on the total amount of franchise tax revenue collected annually across all states.
However, some states do provide information on the revenue generated by franchise taxes within their borders. For example, in 2020, the state of Texas collected approximately $4.1 billion in franchise tax revenue, while the state of California collected approximately $9.4 billion in total corporate tax revenue, which includes franchise taxes.
Franchise taxes are just one type of tax that is levied on businesses in the United States, and the amount of revenue generated by these taxes depends on a variety of factors, such as the size and financial position of businesses subject to the tax, the tax rate set by the state, and the overall economic conditions in the state.
While no comprehensive data has been found on the total amount of franchise tax revenue paid across all states in the United States, franchise taxes are a significant source of revenue for many states and serve to fund public services and infrastructure that benefit businesses and the community.
But a little discussed issue regarding the patchwork of franchise taxes in the United States is the distortion of the free market, which allocates capital to those human enterprises that are most efficient. More on this problem is contained in A Taxing Problem, by Dr. Mitch. In his book Dr. Mitch shows that tax justice would have corporate and corporation-like entities pay taxes like living persons. Since the laws that allow these entities to exist and thrive give them attributes of personhood, they should be required to pay a small annual tax, say 2%, on net worth. The elimination of franchise tax would not only be fairer, but it would allow a significant reduction in the complexity of governments and reduction in the financial costs attendant to that complexity. I would result in a freer market economy and substantially level the playing field of business enterprise.
In Conclusion
Franchise taxes can have a significant impact on lower-income people in the United States, both directly through higher prices and indirectly through reduced access to goods and services. This can exacerbate economic inequality and make it more difficult for lower-income people to achieve financial stability and upward mobility. Franchise taxes can contribute to the consolidation of wealth and power in the hands of large corporations, further entrenching economic inequality in American society.
Policymakers should consider potential solutions to address the deleterious impact of franchise taxes on lower-income people that serve to tip the advantages of the economy in favor of the wealthy and limiting economic opportunity to poor and middle classes in America. Again, a deeper dive into this subject can be had by reading A Taxing Problem, by Dr. Mitch.