What Is Franchise Tax?

How franchise tax works

Franchise tax operates on the principle that businesses benefit from state services and infrastructure, and therefore should contribute to state revenues through this specialized tax. The mechanics of franchise tax involve two critical concepts: nexus determination and entity classification. States use these factors to establish which businesses owe franchise tax and how much they must pay.

What is nexus, and why does it matter?

Nexus is a legal term describing the connection between two or more things. In the franchise tax context, it’s the connection between a taxing entity, such as a state, and a business entity. If your business has nexus in a state, it has sufficient presence to incur tax obligations, including franchise tax. States determine the nexus threshold required for franchise tax liability, and these requirements vary considerably among jurisdictions.

The two primary methods states use to establish nexus are physical presence and economic presence. Physical presence nexus exists when your business has a physical location in the state, whether through owned or leased property or through employees who reside or work regularly in the state. This includes traveling sales teams, remote workers, or temporary business activities that create a substantial connection to the state.

Economic presence nexus applies when your business meets a state's minimum threshold for total revenue earned or the number of transactions completed within the state. Even without a physical location, your business may derive sufficient income from customers in the state to satisfy economic presence requirements. Many states adopted economic nexus standards following the U.S. Supreme Court's 2018 decision in South Dakota v. Wayfair, expanding their ability to tax out-of-state businesses.

Which business entities are subject to franchise tax?

Depending on your local laws, franchise tax may apply to you regardless of your entity type. 

Each state determines the business subject to the franchise tax. Some states require all corporations formed in the state to pay this tax regardless of where they conduct business. Other states apply franchise tax to specific entity types. And even other states, like Wyoming, don’t institute franchise tax.

Certain states provide exemptions based on business type or size. For example, sole proprietorships, general partnerships, and nonprofit organizations can typically avoid franchise tax obligations, while S corporations, C corporations, and limited liability companies are typically subject to it.

State-by-state franchise tax rules

It’s important to understand franchise tax requirements across different states when doing business in multiple jurisdictions. Each state that imposes franchise tax has developed its own system of rates, calculation methods, and compliance requirements. This creates significant complexity for businesses that must navigate varying rules while maintaining compliance in each state where they have nexus.

Get a feel for franchise tax in certain states by reviewing state-specific requirements in Texas, New York, California, Delaware, and Nevada.

Texas franchise tax overview

Texas imposes a franchise tax on most business types, including corporations, LLCs, and limited liability partnerships, that have more than $2,470,000 in revenue (as of 2025). The tax rate varies based on business type and total revenue, with most businesses paying either 0.375% or 0.75% of their taxable margin.

The state of Texas franchise tax uses a unique calculation method based on the business's "margin," which is the lesser of 70% of total revenue, total revenue minus either cost of goods sold or compensation, or total revenue minus $1 million. 

Texas businesses must file and pay their franchise tax by May 15 each year, with payments due at the same time. The state provides an online filing system and requires electronic filing for most businesses.

New York corporate franchise tax overview

New York imposes a franchise tax under Article 9 of the state’s tax law, applying to corporations doing business in the state. As of 2025, the tax rate is either 4.875%, 6.5%, or 7.25% (depending on the type of business) of the company's allocated net income, with a minimum tax ranging from $19 to $200,000 based on the corporation's New York receipts.

The state requires corporations to file Form CT-300 by the 15th day of the third month after the tax year ends. New York also requires estimated tax payments throughout the year, with specific rules for mandatory first installments and quarterly payments based on the previous year's taxes.

Other notable states and unique rules

California imposes an $800 minimum franchise tax on all corporations and LLCs, regardless of income or activity level. This minimum applies even to inactive entities, making it crucial for businesses to properly dissolve entities they no longer need.

Delaware requires franchise tax for all corporations incorporated in the state, even if they conduct no business activities. The tax can be calculated using either the authorized shares method or the assumed par value capital method, with businesses typically choosing the method that results in lower tax liability.

Nevada imposes a commerce tax on businesses with gross revenue exceeding $4 million, calculated at varying rates based on business classification. 

How to calculate and file franchise tax in 5 steps

Following a systematic approach to calculating your specific franchise tax payment helps to ensure compliance and minimize the risk of errors that could result in financial penalties or legal complications. While calculations vary state to state, these general steps can set you up for success.

Step 1: Determine nexus and entity type

Review your business activities in each state to determine where you have nexus for franchise tax purposes. Consider both physical presence (offices, employees, property) and economic presence (sales thresholds, transaction volumes) based on each state's specific criteria. Then, identify your entity type and verify which states require franchise tax for your business structure.

Step 2: Gather required financial information

Collect the financial data needed for each state's calculation method. This may include total revenue or gross receipts, net worth, capital stock values, cost of goods sold, or compensation expenses. Make sure that your information covers the correct tax period and reflects accurate accounting methods consistent with your business records.

Step 3: Calculate tax liability using state-specific methods

Apply each state's calculation method to determine your franchise tax liability in that state. Common methods include percentage of net worth, flat fees, percentage of capital stock value, or margin calculations. Follow the instructions on each official state form to ensure accurate calculations.

Step 4: Complete and file required forms

Prepare your annual franchise tax report using each state's official forms and filing requirements. Many states offer both electronic and mail-in filing options. Include all required supporting documentation, ensuring that forms are signed and dated appropriately.

Step 5: Submit payment by applicable deadlines

Pay the franchise tax by each state's deadline to avoid penalties or interest. Keep records of payment confirmations and filing receipts for your business records.

Franchise tax deadlines, penalties, and best practices

Meeting franchise tax deadlines is crucial for maintaining good standing and avoiding costly penalties that can significantly impact your business's financial health. Each state sets its own filing deadlines, penalty structures, and compliance requirements. Understanding these requirements helps protect your business from unnecessary costs and legal complications. 

Franchise tax penalties vary significantly by state but commonly include late filing fees, late payment penalties, and interest on unpaid balances. For example, as of 2025, Texas imposes a 5% penalty for taxes paid up to 30 days late, with additional penalties the later the filing takes, and California charges 5% of the tax due for delinquent filings, up to a maximum of 25%.

The following are some best practices to ensure that your business stays on top of its franchise tax deadlines:

• Maintain a comprehensive calendar of all state filing deadlines
• Set up electronic reminders at least 30 days before franchise tax due dates
• File extensions when necessary while ensuring payments are made timely
• Work with qualified tax professionals for complex multistate situations

Franchise tax vs. state income tax

Understanding the distinction between franchise tax and state income tax is essential for proper business tax planning and compliance. While both are state-imposed taxes on business activities, they serve different purposes and use different calculation methods. 

Many states impose both types of taxes on businesses, creating dual tax obligations that require separate filings and payments. The interaction between these taxes can be complex, particularly for businesses operating in multiple states with varying tax structures.