Understanding Delaware’s Corporate Franchise Tax
Delaware corporations need to understand how their franchise tax is calculated, which is a fee for the privilege of incorporating in the state.
The franchise tax is calculated using either the Authorized Shares Method or the Assumed Par Value Method, with the corporation paying the lesser of the two amounts.
The Authorized Shares Method is based on the number of authorized shares, while the Assumed Par Value Method calculates tax based on the assumed par value of the company's shares, often resulting in a significantly lower tax bill.
Navigating the intricacies of tax liability can often resemble traversing a labyrinth of ever-changing rules and regulations.
For business owners incorporated in the state of Delaware, the annual franchise tax notice they receive can be particularly bewildering.
Some are shocked to find a seemingly exorbitant amount listed on the tax notice, causing understandable concern and confusion.The reality is that your company likely doesn't owe anywhere near the initially stated amount.
In this article, we will delve into the Delaware franchise tax structure, unravel the complexities, and provide a clear understanding of how to compute your tax liability.
By the end, you'll be equipped with the knowledge to confidently tackle your tax obligations and ensure your business remains in good standing in the First State.
Understand what your company actually owes and how to compute your tax liability
For a business owner incorporated in the state of Delaware, it is important to understand how their franchise tax is structured. If you’ve ever received a franchise tax notice from the state of Delaware, you know that they can provide a bit an initial shock.
Companies have been known to receive tax notice stating that your business owes $120K in taxes, when they’ve only started to make sales, leaving them both concerned and confused. However, more often than not, your company will not owe anywhere near this amount.
Let us explain how the Delaware franchise tax works…
Once a year, every Delaware corporation is required to file an annual report that will dictate the amount they owe for their franchise tax. The franchise tax in Delaware is basically the fee that you pay for the ability to incorporating in the state of Delaware and tax advantage of their tax statutes.
More companies incorporate in the state of Delaware than any other state for these, as well as other reasons. Delaware’s Court of Chancery is a highly respected court when it comes to focusing on corporate issues, and most Angel and VC investors, as well as investment bankers, prefer to do business with Delaware corporations.
The franchise tax for corporations is calculated in one of two ways:
The Authorized Shares Method
The Assumed Par Value Method
The corporation then must pay the state the lesser of the two amounts owed using the above methods. By default, Delaware sends out your tax bill using the authorized shares method, which will often be the higher of the two, which is why the tax notice that you receive can be so ridiculously high.
Next, we’ll break down these two methods, so that you’ll have a better idea of how to approach your tax situation.
The Authorized Share Method
When you create a Delaware company, one of the pieces of information you’re required to list in your Articles of Organization is the number of shares that the company is authorized to issue to shareholders. This is the maximum number of shares that a corporation is legally permitted to issue.
These shares should not be confused with the outstanding shares, which are the number of shares the corporation has issued that are held by founders or other investors.
A lot of companies these days, particularly startups, seems to want to authorize millions and millions of shares in the anticipation of large rounds of funding.
If your company has 20 million authorized shares, this will ensure a large franchise tax notice from the state of Delaware, using the authorized shares method of calculation is:
Using the authorized shares method, Delaware will calculate your franchise tax by charging you:
$175.00 flat fee if you have 5k shares or less; or
$250.00 flat fee for your first 10k shares, AND
$75.00 fee for every additional 10k shares, up to a total tax of $200,000.00
EXAMPLE: If you’ve authorized 20 million shares, you’d be charged under the authorized shares method:
$250.00 (for the first 10k shares), plus
$149,925.00 (1999 x $75.00), for the remaining 19.9mm shares
Total Tax Bill: $150,175.00
This can be quite the shock. Especially if your business is pre-revenue which is why they have the assumed par value method as well.
The Assumed Par Value Method
As we mentioned earlier, this is Delaware’s second method that is used to calculate a company’s franchise tax. The tax that you eventually pay that state is based upon whichever method (authorized shares vs. assumed par value) comes up with the smaller amount.
A large percentage of businesses under the assumed par value method, will simply owe the minimum tax under this calculation, or $350.00.
To figure out exactly what this number will be, you’ll have to figure out your “assumed par value”. To explain this, we will be assuming the following for Company A:
Assets: $50,000.00
Authorized Shares: 20,000,000 shares
Shares Issued/Outstanding: 200,000 shares
The basic concept behind the assumed par value calculation is figuring out what the real-world par value of your shares are based upon your company’s assets.
The first step in figuring this out is to divide the dollar value of the company’s assets (as reported on your IRS Form 1120) by the number of shares that have been issued to people. The result is your assumed par value per share:
$50k (assets) / 200k (issued shares) = $0.25 assumed par value per share
Next, we want to find the assumed par value of the company by multiplying the assumed par value per share above by the number of authorized shares as listed in your articles of incorporation (Please take careful note that the number of shares issued and outstanding are different from the number of shares that are authorized):
20mm (authorized shares) * $0.25 (assumed par value per share) = $5mm assumed par value of the company
Under the Assumed Par Value Method, the amount of tax that you pay the state is $350.00 for every $1mm of assumed par value.
To find out how much you own, you’d take the assumed par value of the company, divide it by 1mm, and multiple this number by $350.00 to get your total tax. Thus, the final tax calculations for the company above would look as follows:
Company A
$250k (assets) / 200k (issued shares) = $0.25 assumed par value per shares
20mm (authorized shares) * $0.25 (assumed par value per share) = $5mm assumed pare value of the company
$5 (par value of the company divided by 1mm) * $350.00 (tax on every $1mm of assumed par value) = $8,750.00
Total tax due $1,750.00
As you can see, the difference between the Authorized Share Method and the Assumed Par Value Method can be drastic.
In this case, Company A will pay only $1,750.00 by electing to use the Assumed Par Value Method, instead of the $150,175.00 that was sent to them in their original notice from the state using the Authorized Share Method.
Filing Your Franchise Taxes
Delaware offers a Franchise Tax Calculator in order to assist companies with understanding their tax liability.
Once you’re comfortable with your calculations, you can file the correct franchise tax fees and make a payment online. Payment options at the state’s site are ACH Debit, Visa, MasterCard, Discover or American Express.
These taxes must be paid and signed by the corporation’s president, secretary, treasurer or other proper officer duly authorized to so act, or by any of its directors, or, if filing an initial report, by any incorporator in the event its board of directors shall not have been elected. The incorporator may not sign subsequent annual reports.
