4 Ways To Avoid Franchise Tax?
Franchise tax is a “privilege tax” on business entities that are incorporated or do business in a particular state.
It is considered a privilege tax since it is essentially charging the business for the privilege of operating in the state. This tax, unlike income tax, is based on the net worth or the capital held by the business entity.
These taxes are usually imposed annually by the state agencies.
What determines if a business is operating or doing business within a state? Nexus.
Nexus is the connection between an entity’s business activities and it’s obligation to pay that state’s sales, income, or franchise tax based on those activities. Each state’s nexus requirements differ, so it is important to look into each state where your entity is conducting business. It is entirely possible to create nexus in one state and completely avoid it in another; it simply depends on that state’s particular nexus requirements.
Typical activities that possibly create nexus:
- Physical presence – if a business has a physical presence (examples include: a storefront, headquarters, employees in the state [even temporarily], or independent contractors in the state [even temporarily]) then it will trigger nexus and create a filing requirement for the business.
- Economic presence – nexus can also be created through economic presence (for example, gross receipts based on sales to in-state purchasers). Just as physical presence depends on the state’s rules, economic presence must be defined by the state’s local rules. States have defined this type of “presence” in many different ways.
However, Congress passed Public Law 86-272 in 1959 to outline a few activities that Do Not create nexus:
- Providing services that are ancillary to the sales of property
- Samples and promotional materials for display or distribution without charge
- Maintaining a display room for 14 days or less at a location within the state
- Orders that are accepted and fulfilled outside of the state
Once nexus is established, the business entity will be required to file franchise tax returns with the state. Nexus can be extremely complicated so it important to consult with a tax professional if needed.
Feel free to email us or message us if you have any other tax preparation tips or ideas!
Written by: Nushin Zarrabi Attorney