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Understanding income tax vs corporate franchise tax

Understanding income tax vs corporate franchise tax

Understanding the tax system and the tax responsibilities of the citizen to the federal and state government as it concerns the location of business operations is an essential duty of every business owner. Ignorance is not an excuse and therefore there are penalties and punishments for irresponsible tax behavior. It is essential for every business owner to understand their tax responsibilities accurately and take a step further by fulfilling those tax responsibilities.


For businesses, there are two major taxes are usually assessed. They are the corporate income taxes and franchise taxes. They are not the same and the difference lies in what is being taxed and who in particular is doing the taxing. When we refer to income taxes, it applies to the profit of the business, however, franchise taxes do not apply to profit.

Corporate Income Tax

Income tax usually applies to the net profit of the business entity because it is usually calculated based on the corporation’s net profit for the year. Consequently, if no Profit is made for the year, no income tax will be required. Income tax applies to all corporations that make income from within the state, including corporations that might not physically do business in that state but generate income from the state.

Corporate Income tax payment only applies to Corporations. However, sole proprietorship, limited liability companies, and partnerships are not required to pay income taxes, their taxes are usually paid by the owner(s) in their personal income tax.

A corporate income tax is defined as a direct tax imposed by a jurisdiction on the net income or capital of corporations. The corporate income tax is imposed by the federal government, but some states also impose it on business organizations within their state.

The Corporate income tax usually applies to corporations incorporated in the country, corporations doing business physically in the country with income from the country,  foreign corporations who have a physical presence for their business corporations in the country, or other business structures that the IRS deems taxable. Depending on the state or country, the taxing system for companies can differ. Some countries tax only Corporations on their net profit while others will tax the individual partners in companies for their distributive share in the company’s profit.


Franchise Tax

A franchise tax is a government tax/levy charged annually by some states to certain business organizations for the right to legally do business within that state. When a business organization refuses to pay franchise taxes, it can result in becoming disqualified from incorporating or doing business in that state.

The franchise tax is not limited to franchise businesses, it is also charged to corporations, partnerships, and limited liability corporations (LLCs) that do business within a given state.

This tax is usually imposed by a state on corporations, LLCs, and partnerships. It is levied on these companies for the privilege of either doing business in the state or incorporating their business in that state. When a business fails to pay a franchise tax, it may result in dire consequences such as the disqualification of all business operations within that state.

Franchise taxes are not based on the corporation’s profit and must be paid whether the corporation makes a profit in the year or not. Franchise Tax could be a simple flat rate for some states, it could also be based on the company’s net worth, gross receipts, and other relevant documents.

The federal government does not usually impose a franchise tax, it is usually imposed by certain states. Some states only impose a franchise tax on Corporations that have a physical presence or location for business operations within the state. Franchise taxes are also imposed on businesses that incorporate with other businesses within a state. For some states, even without a physical presence of the business, a franchise tax is allocated if revenue is generated from the state like in the case of shipping of goods to buyers for sale. However, the payment not franchise tax depends on the rules and taxing system in a particular state of interest.


Franchise tax is usually seen as not too good for businesses and most business entities refuse continued business operations in states where franchise taxes are too high. This is because the franchise tax is imposed alongside other taxes like the income tax and it is still required even if the business entity makes no profit in that year. This leads to a high tax liability which can be a problem for business owners. The determination of franchise tax to be paid by business owners differs from state to state.

Do you need help sorting out your income and franchise taxes? Then you have come to the right place.

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Internet subscribers, users, and online readers are advised not to act upon this information without seeking the service of a professional accountant. Any U.S. federal tax advice contained in this website is not intended to be used for the purpose of avoiding penalties, of any kind, under U.S. federal tax laws.