A state tax on businesses that are incorporated or operating within that state. Contrary to what the name suggests, this has nothing to do with taxing franchises. Instead, it is a tax on the opportunity to do business in any given state.
About half of U.S. states do not impose a franchise tax. Among the states that do impose a tax, the way it is calculated can vary wildly. It may be a flat fee, a percentage of the company’s net worth, a portion of the company’s gross receipts or a portion of the value of the business’ capital stock. Some states use calculations based on metrics that would confuse the average non-accountant. Suffice it to say, franchise taxes can be a headache, depending on where your company does business.
There is also some debate over what it means to operate within a state. Some states consider only a company’s physical presence (brick-and-mortar stores), while others consider its economic presence (transacting with customers in the state). With the huge growth in online retail, this distinction has become even more important.
A great many companies decide to incorporate in Delaware despite not having a physical presence in the state. This is because Delaware has very business-friendly laws and policies. However, Delaware also imposes a notably high franchise tax, which should be taken into consideration when deciding where to incorporate.