How (and When) to File Delaware Corporate Franchise Taxes
Delaware's reputation as a business-friendly state has made it a popular choice for companies to incorporate. However, with the benefits come certain obligations, and one of the key financial responsibilities for businesses in Delaware is the payment of franchise taxes. Here, we outline how Delaware calculates franchise taxes, shedding light on a process that might seem complex to many business owners.
Do I really have to pay that much?
Before we dive into more detail, your corporation may have received a franchise tax bill from the Delaware Division of Corporations for tens of thousands of dollars (or more)! Don’t worry, and don’t pay that bill until you confirm the amount you actually owe. As we discuss below, there are two ways to calculate franchise tax, and they result in drastically different payment obligations. Delaware will always send corporations a bill showing the higher tax amount. However, under Delaware law, corporations are only required to pay the lesser of the two tax amounts.
What are franchise taxes?
Franchise taxes in Delaware are an annual fee that all corporations incorporated in the state must pay to maintain their legal existence. These taxes are not based on income or profit. Instead, they are considered a cost of doing business in Delaware.
There are two methods to calculate a corporation’s franchise tax obligation: the “Authorized Shares Method” and the “Assumed Par Value Capital Method.”
The Authorized Shares Method involves a more straightforward calculation of the two methods. Your corporation pays a fee based on its total number of authorized shares. It's important to note that the focus here is on authorized shares, not the number of shares actually issued to stockholders or reserved as part of a stock option plan or other equity incentive plan. The number of authorized shares is defined in a corporation’s Certificate of Incorporation. If you have over 10,000 authorized shares, those first 10,000 shares accrue a $250 tax. Your corporation will then owe an $85 for each additional 10,000 authorized shares. The minimum tax when using this method is $175, and the maximum tax is $200,000. Note: if your corporation’s stock has no par value (listed in the Certificate of Incorporation), it must use the Authorized Shares Method to calculate its annual franchise tax.
The Assumed Par Value Capital Method is a bit more complex. This method calculates franchise tax based on your corporation's “assumed par value capital”, which is the corporation’s total gross assets multiplied by the ratio of authorized shares to issued shares. Every $1,000,000 in assumed par value capital is then taxed $400. So, the higher the ratio of authorized shares to issued shares, and the higher your corporation’s gross assets, the more franchise tax your corporation will pay. The minimum tax when using this method is $400, and the maximum tax is $200,000.
In additional to the franchise tax fee, your corporation will pay an “annual report fee”, a flat fee paid by all corporations, regardless of the franchise tax calculation method used.
Here’s an example to demonstrate how drastic the difference can be.
Assume a Delaware corporation called ABC, Inc., has $50,000 in total gross assets, 5 million issued shares, and 10 million authorized shares.
Under the Authorized Shares Method, because ABC has over 10,000 authorized shares, they already owe $250. Their total franchise tax bill will be $250.00 plus $85.00 for each additional 10,000 shares.
Subtract 10,000 shares to determine the amount of shares to be charged at the $85 rate.
10,000,000 shares - 10,000 shares = 9,990,000 shares
Divide by 10,000 shares to determine the number of times the $85 rate will need to be charged.
9,990,000 shares ÷ 10,000 shares = 999
Multiply the number of times the $85 rate will be charged by $85.
999 × $85 = $84,915
Add $250, the rate charged for the first 10,000 authorized shares, to the amount from the prior step, to obtain the total amount owed.
$84,915 + $250 = $85,165
ABC’s franchise tax would be $85,165.
Alternatively, under the Assumed Par Value Capital Method, franchise tax would be calculated as follows:
Divide total gross assets by total issued shares to get the assumed par value.
$50,000 ÷ 5,000,000 shares = $0.01
Multiply the assumed par value by total authorized shares to get the assumed par value capital.
$0.01 x 10,000,000 shares = $100,000
Every group of $1,000,000 in assumed par value capital is taxed $400. Divide the assumed par value capital by $1,000,000 to determine the number of groups of $1,000,000 to be taxed.
$100,000 ÷ $1,000,000 = 0.1
Multiple the number of groups by $400. Since ABC's assumed par value capital falls below $1,000,000, ABC’s franchise tax will be $400 (the minimum tax).
The difference would between these two calculation methods is over $84,000 dollars! Delaware would likely send ABC a bill for the higher amount, but ABC can actually save substantial money for growing the corporation and furthering its stockholders’ best interests.
How to calculate franchise tax
Always check both calculation methods to make sure your corporation is paying the lowest possible franchise tax.
Here’s the information you’ll need:
Your corporation’s “total gross assets” as of the fiscal year that ended during the last calendar year (for most corporations, that’s December 31). Total gross assets are the assets your corporation reported (or will report) on the U.S. Form 1120, Schedule L (Federal Return). You’ll likely want to confirm this amount with your accountant or CPA.
Your corporation’s total authorized shares. This number will be listed in the most recent version of the corporation’s filed Certificate of Incorporation.
Your corporation’s total issued shares, which is the number of shares actually issued and held by stockholders. Check your corporation’s most recent capitalization table to find this number. This number excludes shares and unconverted option grants reserved under a stock option plan or other equity incentive plan.
Check the Authorized Share Method:
Total authorized shares - 10,000 shares = shares subject to $85 rate
Shares subject to $85 rate ÷ 10,000 shares = number of groups to be charged $85
Number of groups to be charged $85 * $85 + $250 = total franchise tax owed. (The $250 the rate for the first 10,000 shares we removed in the first step.)
Minimum franchise tax is $175, and the maximum is $200,000
Compare that against the Assumed Par Value Capital Method:
Total gross assets ÷ total issued shares = assumed par value
Assumed par value * total authorized shares = assumed par value capital
$0.01 x 10,000,000 shares = $100,000
Assumed par value capital ÷ $1,000,000 = number of groups to be taxed
Number of groups * $400 = total franchise tax
Minimum franchise tax is $400, and the maximum is $200,000
If you don’t want to run through a franchise tax calculation by hand, the Delaware Division of Corporations has a handy calculator you can download as an Excel file here: https://corp.delaware.gov/taxcalc/.
How to file a corporation’s annual report and pay franchise tax
The easiest and most efficient way to pay your corporation’s franchise taxes and file your annual reports is to coordinate directly with your Delaware registered agent. You will need to provide them with the corporation’s gross assets and issued shares (they should already know the authorized share numbers). Some registered agent companies, like Incorporating Services, Ltd., provide annual report filing services to help you timely file your annual reports and pay your franchise taxes each year. But keep in mind you need to promptly respond to their requests for information needed to make these filings!
Alternatively, many law firm staff can support clients’ annual report filing needs. Ask your attorney if they can help you file your annual report.
Finally, your team can make this filing and corresponding payments with the Delaware Division of Corporations directly here: https://corp.delaware.gov/paytaxes/
Penalties for non-compliance
It's essential for corporations to adhere to Delaware's franchise tax requirements to maintain good standing. Failure to pay franchise taxes on time can result in penalties and interest, which can accumulate quickly. In extreme cases, non-compliance can lead to the administrative dissolution of the corporation. If your corporation is administratively dissolved, it technically doesn’t exist anymore, and any contracts, agreements, or other arrangements you enter into during administrative dissolution are void. Directors or officers taking action on behalf of the corporation during administrative dissolution expose themselves to personal liability and the risk of fiduciary duty lawsuits. Reinstating an administratively-dissolved corporation involves making a few filings, obtaining written consents, paying overdue taxes and penalties, and cleaning up any contractors, agreements, or other actions taken during administrative dissolution to ensure those are valid.
Final considerations
Choosing the most favorable calculation method of franchise tax can drastically influence your company’s financial obligations to the State of Delaware. In line with the differences we’ve outlined above, here are a few things to keep in mind as you start and grow a Delaware corporation:
Make sure the initial Certificate of Incorporation you file with the Delaware Division of Corporations includes a nominal par value (we usually use $0.00001 for our clients). Par value is basically meaningless nowadays, but corporations with stock that has no par value must use the Authorized Share Method to calculate franchise taxes. As we’ve seen, this almost always results in substantially higher franchise taxes.
Under the Assumed Par Value Capital Method of calculating franchise taxes (which almost always is results in the lowest tax obligation), the ratio of authorized shares to issued shares matters. If your corporation has authorized multiple times the number of shares it’s issued, it may have substantially higher franchise tax obligations than if the authorized share and issue share numbers are more closely aligned. Corporations generally need more authorized shares than issued shares to account for (among other things) potential future share issuances or the conversion of convertible debt. However, authorized shares should never be set too much higher than necessary.
Prioritize timeline filing your franchise tax fees by March 1st of each year in order to avoid penalties and administrative dissolution.
As with any financial matter, seeking the guidance of a qualified professional can be invaluable in ensuring compliance and optimizing the tax position of your corporation in Delaware.
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