The vast majority of companies and startups are incorporated in Delaware because they are not liable for State-level corporate income tax in Delaware. However, this exemption is not applicable to franchise tax. If you are incorporated in Delaware, you are most likely liable for franchise tax. This guide will provide you with simple tax advice to ensure that Delaware franchise taxes are the last of your worries as you grow your business.
Do I Have to Pay a Franchise Tax in Delaware?
Non-stock and non-profit companies are exempt from the franchise taxes in Delaware. All other business entities have to pay a franchise tax. A Delaware Limited Liability Company (LLC) or a Delaware Limited Partnership (LP) is liable for an annual franchise tax at a flat rate of $ 300.
If you are a Delaware Corporation, franchise tax calculations are not quite that simple. This doesn’t mean that it will be a nightmare to file your taxes: the State provides a useful tool to calculate your franchise tax, and we provide a quick tour of the two methods of franchise tax calculation here.
All of the entity types listed here, whether exempt or non-exempt from franchise taxes, must file the tax return and pay the annual report fee ($50 or $25 depending on entity type). As an aside: remember that, if your business is incorporated in another state, or if you conduct business in other states, you might also be subject to franchise taxes in those other states.
1. The Authorized Share Method
Delaware uses the authorized share method as default to calculate the franchise tax for which you are liable. If you take no action from your side, therefore, your franchise taxes will be calculated with this method.
The authorised share method works as follows, although the rates mentioned here are subject to change:
A Corporation with 5,000 authorizes shares or less will pay a franchise tax of $175. A Corporation with 5,001 to 10,000 authorized shares will pay a franchise tax of $250. For each additional 10,000 shares or portion thereof, $85 is added to the franchise tax liability (this was $75 up until the 2017 tax year).
The franchise tax bill for this method can quickly add up, depending on how your corporation is structured. For example, a Delaware Corporation with 15 million shares would have had to pay franchise tax of $112,425 for the 2017 tax year.
The Assumed Par Value Capital Method
Although the assumed par value capital method is somewhat more complicated, it often results in a lower franchise tax liability. The basic intuition behind this method is as follows: the par value per share of a corporation is taken, and this is multiplied by the number of shares it has issued. The result gives the corporation’s market capitalization. This is rounded to the nearest million dollars, and 0.035% of that is the franchise tax for the year.
Most companies determine very low par values in their certificates of incorporation (for example, $ 0.001). To deal with this, Delaware uses an assumed par value and not he par value set out in certificates of incorporation. The assumed par value is simply the corporation’s gross assets divided by all of its shares (both issued and unissued).
To be able to use this method, you have to provide proof of your company’s gross assets, as well as your total amount of issued and unissued shares. Generally, Delaware accepts U.S. Form 1120, Schedule L as a proof of your gross assets. This is where you declared your assets for corporate income tax purposes. You must submit the form from the relevant tax year. If you have not yet filed your income tax return for the year, you can provide the value of your total gross assets from a recent balance sheet and amend it later when you do file your taxes.
The minimum franchise tax liability under this method is $350, and the maximum is $180,000.
Minimizing your Franchise Tax Liability
If you are a small business or a startup, you will usually be liable for much less under the assumed par value capital method than under the authorized share method. However, if you have authorized a very large number of shares and only issued a few of them, this might not be the case. As long as you have issued between a third and half of your authorized shares, you are probably better off with this method than with the authorized share method. Although it takes a bit more effort to prove and calculate, it might be well worth the time in savings.
Some Practical Advice for Filing Your Taxes
First off, be sure to file your annual reports in time. Franchise taxes are due in arrears for the prior calendar year. Franchise taxes are due March 1st of every year. On this date, the tax itself must be paid and the report filed. Reports must be filed electronically. Finally, remember to add the filing fee to your total payment.
If your company owes more than $5,000 for the prior year, you are required to make estimated payments for the tax year going forward: 40% payable by June 1st, 20% payable by September 1st and again by December 1st, and the remainder by March 1st.
Failing to pay franchise tax in time is penalized with a $200 fine plus penalty interest of 1,5% per month on the outstanding balance. Perhaps more significantly, your company will not be in good standing with Delaware until your taxes are paid in full, which might delay possible investments or fundamental transactions. Franchise taxes are well worth your attention, therefore!
Have All Your Legal Questions Answered
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