A Franchise Tax is a tax levied on certain enterprises in some states and is paid in addition to real estate taxes and income taxes. In essence, it is a tax that certain businesses pay for the right to operate within a state’s confines.
Currently, Alabama, Arkansas, California, Delaware, Georgia, Illinois, Louisiana, Mississippi, New York, North Carolina, Oklahoma, Tennessee, and Texas are the only states that impose Franchise Taxes. Many of these states calculate Franchise Tax using differing methods. Typically, it is calculated based on a given company’s margin, which can be determined via a number of processes. This margin that influences the amount of Franchise Tax a company pays is based on either their capital stock, their gross receipts, their assets, their paid-in capital, or their net worth. Although, some states do offer a flat fee as their Franchise Tax.
Many companies make a conscious decision to officially operate in states where Franchise Taxes are not imposed to avoid paying extra. However, some businesses that operate within states that impose a Franchise Tax are exempt from paying this fee. Some organizations which are exempt are listed below:
Real Estate Mortgage Investment Conduits (REMICs)
Trusts that are exempt under the Internal Revenue Code Section 501 (c)(9)
Nonprofit Organizations
Most Sole Proprietorships (not including Single Member LLCs)
Certain Real Estate Investment Trusts (REITs)
Estates of natural persons
General partnerships where direct owners are all natural persons
*Limited liability partnerships still pay a Franchise Tax*
Unincorporated political committees
Certain escrows
Trusts that are qualified under the Internal Revenue Code Section 401(a)
Certain grantor trusts
Entities exempt under the Tax Code Chapter 171, Subchapter B
Nonprofit self-insurance trusts created under the Insurance Code Chapter 2212
Certain unincorporated passive entities
It is important to be aware of what type of business one owns, and whether or not that specific type of business is exempt from paying this extra expense. Also, it is just as important to know the specific legislation regarding the Franchise Tax in the specific state where the business is operating.
Franchise Tax vs. Income Tax
While all businesses must pay Income Tax, only certain businesses are required to pay a Franchise Tax. Also, while the amount of Income Tax a company pays is strictly dependent on how much income it generates each year, Franchise tax is contingent on a number of factors separate from their amount of income as detailed out above.
Franchise Tax in Real Estate
At Top Shelf Models, the Franchise Tax is an important component of the Monthly Cashflow tab in our multifamily models. It is not always utilized in our models, as only certain companies in certain states need to account for this expense. For those businesses that are required to pay a Franchise Tax, it is important that it is accounted for under the expense column of the cashflow tab, as it is an integral piece of the total operating expenses calculation, which in turn is used to provide the net operating income and the internal rate of return.
In our models, the Franchise Tax assumption is expressed as a simple percentage of the property’s Scheduled Base Rental Revenue. This calculation might have to be adjusted depending on where one’s business is located and how the Franchise Tax is calculated in that specific state. For simplicity purposes, it gives a solid estimation of what one can expect the Franchise Tax to be in most cases.
Conclusion
Franchise Tax is a complicated yet important expense that all real estate professionals should recognize. It is important to know whether or not this tax applies to one’s business and how it is calculated within said business’ respective state.
About the Author
Brittany Martin is TSM’s Vice President who has developed real estate financial models for an extensive range of property types. She specializes in land, hotel, and storage models. Please reach out to her if you have any questions on Franchise Tax or if she can help you with your modeling needs.
