A franchise tax is generally not an income tax. A state usually imposes a franchise tax on a business for the privilege of incorporating, existing as a legal entity, or doing business in the state. An income tax applies to taxable income or profit.
The answer depends on the state. Some franchise taxes use income, revenue, margin, shares, or net worth to calculate the amount owed.
| Feature | Franchise Tax | Income Tax |
|---|---|---|
| Main purpose | Charges for the privilege of incorporating or doing business | Taxes taxable income or profit |
| Common tax bases | Shares, net worth, gross receipts, revenue, margin, or income | Taxable income after allowable deductions |
| Profit required? | Often no. A business may owe a minimum franchise tax while inactive or operating at a loss | Usually tied to taxable income, although minimum taxes and alternative taxes may apply |
| Typical taxpayer | Corporations, LLCs, partnerships, and other registered entities | Businesses and individuals with taxable income |
| Federal equivalent | The United States does not impose a federal franchise tax | The federal government imposes federal income tax |
Why Franchise Tax Is Different From Income Tax
A franchise tax is generally based on a business's legal status or right to operate, rather than only on its profit. A business may owe the tax even when it has no taxable income.
The Legal Information Institute describes franchise tax as a state charge for the privilege of operating as a corporation or business entity, rather than an ordinary income tax.
A state can impose both taxes. For example, a corporation may owe income tax on taxable profit and a separate franchise tax for the privilege of doing business or maintaining its registration.
Why the Answer Varies by State
States use the term "franchise tax" differently. The name of the tax does not always show how the state calculates it.
Texas Franchise Tax
Texas describes its franchise tax as a privilege tax imposed on taxable entities formed or organized in Texas or doing business there. Texas generally calculates the tax using taxable margin. The calculation may use total revenue, cost of goods sold, compensation, or a percentage of revenue.
The Texas franchise tax is therefore different from a traditional corporate income tax based on net profit.
Delaware Franchise Tax
Delaware corporations must pay an annual franchise tax for the privilege of incorporating in Delaware, even if they do not conduct business in the state. The tax may be based on authorized shares or assumed par value rather than annual profit.
California Franchise Tax
California shows why the distinction can be confusing. A corporation's franchise tax is generally the greater of an amount based on California net income or an $800 minimum franchise tax.
A corporation may owe the minimum amount even if it is inactive or operating at a loss. California separately identifies a corporation income tax for corporations that receive California-source income but are not doing business in California.
A franchise tax can therefore use income as its measure without being classified as a conventional income tax. The state's legal definition and filing rules still control.
Is Franchise Tax Deductible as an Income Tax?
Generally, a corporate franchise tax is treated for federal purposes as a business tax expense rather than as an individual state income-tax payment. Federal tax authorities have recognized state franchise taxes as deductible taxes imposed on corporations, subject to the relevant accounting and deduction rules.
The treatment depends on:
- The state imposing the tax
- The business entity paying it
- Whether the business uses cash or accrual accounting
- Whether the tax is imposed on the entity or its owner
- The applicable federal and state deduction rules
Bottom Line
The state and tax base control the answer. A tax called a franchise tax may use income, revenue, or taxable margin as its measure, while its legal classification and filing rules remain separate from those of an income tax. Check the rules for the specific state and business entity before determining how the tax applies.