What is a Franchise Tax?

How is the Franchise Tax Calculated?

The states might levy the tax based on the following methods:

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#1 – Business Profit Margin Method

Under this, the profit marginProfit MarginProfit Margin is a metric that the management, financial analysts, & investors use to measure the profitability of a business relative to its sales. It is determined as the ratio of Generated Profit Amount to the Generated Revenue Amount. read more is calculated first by subtracting costs and expenses from the corporation’s revenue and multiplying the margin by a percentage of business done in that state. For example, if a corporation does only 70% of its business in that state, then tax will be calculated on a 70% margin. For a corporation that operates entirely in the state will pay franchise tax on 100% of profits. The margin calculated is then taxed as per applicable tax rates of the state.

#2 – Authorized Shares Method

The tax is calculated by multiplying the total number of authorized shares the company has as per its charter by the tax prescribed per share.

Examples

Let us understand the above methods by way of examples.

Example #1 – Business Profit Margin Method

A company has earned a revenue of $5,000 during the year. Also, the company incurred expenses of $3,500 to earn revenue. The jurisdictional state levies tax at the rate of 10%.

Solution

Calculation of Profit Margin

  • = $5,000 – $3,500Profit Margin = $1,500

Franchise Tax can be calculated as follows:

  • = $1,500 * 10% = $150

Example #2 – Authorized Shares Method

A company has 7,000 of total authorized shares. The state levies a franchise tax of $2 per share.

  • = $2 * 7,000= $14,000

How do Companies Pay Franchise Tax?

Franchise Tax vs. Income Tax

Companies may be subject to income tax or corporate tax. While income tax is being levied on profits earned by the company while franchise tax does not apply on profits. Instead, the corporation is taxed for the privilege they enjoy operating in the state.

  • Estimation of tax as per the state laws Based on whichever method the state prescribes. File the tax report. The report contains the details of the revenue as well as the calculation of tax paid. There can be following types of return:– No tax due: If the annual turnover falls below the prescribed limit, then no franchise tax will be levied, and this tax report can be filed.– E-Z Computation tax form and Long-form: Based on the annual turnover limits set by the state, the form can be selected. File a public information report. It is a form every corporation is required to file with the state. File additional forms if they apply to you. Prepare and file franchise tax reports with the state.

Based on whichever method the state prescribes.

The report contains the details of the revenue as well as the calculation of tax paid. There can be following types of return:– No tax due: If the annual turnover falls below the prescribed limit, then no franchise tax will be levied, and this tax report can be filed.– E-Z Computation tax form and Long-form: Based on the annual turnover limits set by the state, the form can be selected.

It is a form every corporation is required to file with the state.

Income tax is levied as per flat rates for the corporation on their profits. On the other hand, it can either be based on profit margin or share capitalShare CapitalShare capital refers to the funds raised by an organization by issuing the company’s initial public offerings, common shares or preference stocks to the public. It appears as the owner’s or shareholders’ equity on the corporate balance sheet’s liability side.read more.

A corporation will pay income tax only when it has profits and not in case of losses. But it may also be payable in the absence of the profits as the same can be levied on share capital basis also.

Conclusion

Corporate set up or operating in states shall check whether that state is levyingLevyingA levy is a lawful process where the debtor’s property is seized when the debtor cannot pay the outstanding debts. It is different from liens, as a lien is only a claim against a property, whereas a levy is an actual property takeover to fulfill the obligation.read more the franchise tax or not. Also, various types of corporations are exempted from this type of tax. One should check whether they fall within the purview of those exemptions. It is payable annually. It shall be paid without any failure or delay, as the same can lead to levy of penalty.

This article has been a guide to Franchise Tax and its definition. Here we discuss how to calculate franchise tax with the help of examples, how companies pay it, and its differences from income tax. You can learn more about finance from the following articles –

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