Calculating And Paying Delaware Franchise Taxes — Startups Need Not Panic
By Louis Lehot, business lawyer and partner at Foley & Lardner LLP in Silicon Valley, and formerly the founder of L2 Counsel, P.C. and the video blog series #askasiliconvalleylawyer
Have you recently received a letter from the State of Delaware stating that your startup owes thousands of dollars in franchise tax? Do not panic!
All Delaware corporations are required to pay an annual franchise tax to the state, even if your business is not a franchise. There are two methods for calculating Delaware franchise taxes, and Delaware defaults to the one that is more expensive than the other. However, you will likely be able to use the cheaper option.
Delaware franchise tax is the fee imposed by the state of Delaware for the right or privilege to be incorporated in the State of Delaware as a company. Think of it as a license fee to operate a corporation. The tax has absolutely no relevance to your company’s income — the State of Delaware requires it in order to maintain the good standing status of your company.
Today, the franchise tax for a Delaware limited liability company (or LLC) or Delaware limited partnership (or LP) is a flat annual rate of $300, while the franchise tax for a corporation is based on your type of business and the number of authorized shares. The total cost of Delaware franchise taxes includes an annual report fee as well as the actual tax. However, a non-profit is exempt, as this type of business does not pay the yearly tax, although must still file and pay the annual report fee of $25. A company with 5,000 authorized shares or less is considered a minimum stock corporation and must pay an annual report fee of $50 and about $175 in tax. Additionally, a company with 5,001 authorized shares or more is a maximum stock corporation with a report fee of $50 and a range of between $200 and $200,000 per year in tax.
Currently, there are two methods used to calculate franchise tax in Delaware. First is the “authorized shares method,” which Delaware uses to calculate your taxes initially. The calculation consists of: 5,000 shares or less: $175; 5,001–10,000 shares: $250; Additional 10,000 shares or portion thereof: add $85 and; the maximum annual tax is $200,000. Second is the “assumed par value capital method,” which is most often the cheaper option of the two methods. To use this method, you must provide the company’s total gross assets and the total number of issued shares. The resulting franchise tax is most often a minimum payment of $400 tax, plus the $50 annual report fee for $450 due per year.
The gross assets come from Schedule L to federal tax form 1120 for the same year the company is filing its annual report. The par value used to compute the tax is the greater of the “assumed par value” or the actual par value listed in the certificate of incorporation. Usually, startups can minimize taxes by using the assumed par value capital method, since it calculates tax as a total asset function. The only downside is that even a company with few assets could end up owing a lot of franchise taxes if it authorizes a large number of shares while issuing a small percentage of them. But, as long as your issued shares consist of at least a third to a half of your authorized shares, the alternative par value capital method will work.
All Delaware franchise taxes are due March 1st of every year for the previous year. A company must pay via the filing of an annual report with the Secretary of State of Delaware. You can then file the report online and enter the information, including the address of the business, the address of the registered agent in Delaware, a list of all directors, at least one officer, the number of issued shares, and finally, the amount of gross assets.
If a company owes more than $5,000 in franchise taxes, it must make quarterly tax payments via credit card. Those are due at the end of the second month following each quarter, and any positive balance goes towards the following year. If you miss the deadlines, it will cause a company to fall out of good standing with the state, which can complicate, delay and possibly prevent future transactions, so be sure to meet all necessary deadlines.
Louis Lehot is a partner and business lawyer with Foley & Lardner LLP, based in the firm’s Silicon Valley, San Francisco and Los Angeles offices, where he is a member of the Private Equity & Venture Capital, M&A and Transactions Practices and the Technology, Health Care, and Energy Industry Teams. Louis focuses his practice on advising entrepreneurs and their management teams, investors and financial advisors at all stages of growth, from garage to global. Louis especially enjoys being able to help his clients achieve hyper-growth, go public and to successfully obtain optimal liquidity events. Louis was the founder of a Silicon Valley boutique law firm called L2 Counsel. He previously served as both the co-managing partner and co-chair of the emerging growth and venture capital practice of a global law firm in Silicon Valley.
