If your business is incorporated or formed in Delaware, every year you’ll receive a bill for something called a franchise tax. Franchise taxes are imposed on businesses for the privilege of incorporating in the State of Delaware. The name is slightly confusing, because it doesn’t mean your business is a franchise, and it doesn’t replace state or federal income taxes. The way franchise taxes are calculated can seem complicated at first, but we explain how to do it below.
Paying the Bill
There are three steps to paying a franchise tax bill:
- Calculate the amount your company owes using either the Authorized Shares Method or the Assumed Par Value Capital Method
- Enter your company’s information into the Delaware franchise tax portal
- Pay the franchise tax
What are the Authorized Shares Method and Assumed Par Value Capital Method?
The amount of your franchise tax is calculated using one of two methods, the Authorized Shares Method or the Assumed Par Value Capital Method. Delaware defaults to the Authorized Shares Method, because it has the information needed to calculate that on file from your Certificate of Incorporation. However, the Authorized Shares Method can sometimes result in an absurdly high franchise tax bill. For that reason, it’s important to take the time to determine which method is best suited for your company.
Authorized Shares Method
The Authorized Shares Method is simple to calculate. First, it would be helpful to get a copy of your Certificate of Incorporation. Once you have that, take a look at the number of authorized shares. Then:
- If your company has 5,000 authorized shares or fewer, the franchise tax is $175
- If your company has between 5,001 and 10,000 authorized shares, the franchise tax is $250
- For each 10,000 authorized shares over the initial 10,000, there is an additional fee of $85
Let’s try an example. Say your Certificate of Incorporation authorizes 10,000,000 shares of common stock, which is not an unusual number for tech startups to use. You will owe at least $250 in franchise tax because your authorized shares are more than 10,000. If we take the remaining shares after hitting the 10,000 mark – 9,990,000 – and divide by 10,000, we get 999. Multiply that number by $85, and we get: $84,915. So your franchise tax bill is: $85,165?
As you can see, this is an irrationally high number, and would not be feasible to pay for a new company with no revenue. The Authorized Shares Method works well if you have a low number of authorized shares. The minimum franchise tax bill using the Authorized Shares Method is just $175, so it is cheaper in some instances. But, if you want to eventually accept venture capital investment, or issue stock options to your employees, you will need a lot of authorized shares. This will result in a high franchise tax based on the Authorized Shares Method. Fortunately, there’s another way to calculate the franchise tax which makes more sense for the modern startup: the Assumed Par Value Capital Method.
Assumed Par Value Capital Method
Using the Assumed Par Value Capital Method, you will pay $400 for every $1,000,000 in “assumed par value” of the company. To calculate, you will again need to look at your Certificate of Incorporation, but you will also need to know some additional information about the value of assets in your business. You can get this from Schedule L of your federal tax return Form 1120.
Here’s the information you’ll need:
- Number of Issued Shares
- Number of Authorized Shares
- Par value for the Authorized Shares
- Total Gross Assets (see Schedule L of Form 1120)
As an example, let’s suppose a company has $500,000 in Gross Assets; 10,000,000 authorized shares of common stock with a par value of $.001 per share; and 1,000,000 shares which are issued to founders and other company employees.
The owner of the company will take the above information and calculate as follows:
1) Determine the Assumed Par, which is equal to the amount of Gross Assets divided by Issued Shares, carried to six decimal places. For our example, the Assumed Par is $.500000.
2) Multiply the Assumed Par by the Authorized Shares which have a par value less than that of the Assumed Par. Because the Assumed Par is $.500000 and the par value of the Authorized Shares in our example is $.001, this would be all of the Authorized Shares. Our result is $5,000,000.
3) Multiply the Assumed Par by the Authorized Shares which have a par value less than that of the Assumed Par. In our example, there are none, so the result is $0.
4) Add the numbers from steps b and c above to determine the Assumed Par Value Capital. $5,000,000 + $0 = $5,000,000.
5) Divide the Assumed Par Value Capital by $1,000,000. Our result is 5.
6) Multiply the answer in step e above by $400. Here, that would be $2,000. This is the total amount in franchise tax owed by the company in our example.
Don’t want to do the math on your own? Use this calculator provided by the Delaware Secretary of State. The minimum amount of franchise tax owed using the Assumed Par Value Capital Method is $400.
Summary
Franchise fees are an ongoing cost of doing business as a Delaware company. However, newly minted startups should expect a relatively low franchise tax bill every year. Also remember that in order to get the most current franchise tax figures, you should check the franchise tax page of the Delaware Secretary of State’s website. Many commercial websites contain outdated information and will provide you with an incorrect amount. The figures used in this article are current as of 07/13/2020. Franchise taxes are due on March 1 each year.
Bob Baker is a founding partner of Peak Corporate Counsel. He has worked with numerous founders on a variety of issues specific to startups. When he’s not advising innovators, he can be found at networking events, playing rugby, or hiking with his kids.
This article is for informational purposes only, and may not be considered legal advice.