Sticker Shock over Your Delaware Franchise Tax Bill??? There’s a Solution for That!

Because of its business-friendly environment, Delaware remains a popular choice of state for incorporating businesses in the US, including US subsidiaries of UK companies. But with incorporation in Delaware, comes the Delaware Franchise Tax.

A franchise tax is a fee paid to the government of a US state for the right to operate as a legal entity within that state. Failure to pay the annual franchise tax can result in penalties, fines or even the loss of the right to operate as a legal entity within that state.

Unlike income taxes, which are based on profits, franchise taxes may be a flat fee or calculated using factors such as authorised or issued shares or the corporation’s assets. Franchise taxes are not based on income and are separate from, and additional to, US federal and state income taxes.

The Authorised Shares Method calculates the annual franchise tax based on the total number of shares a corporation is authorised to issue, starting with a minimum tax of $175 per year, with the tax rate increasing as the number of authorised shares increases, up to the $200,000 maximum per year. Because it is based on the number of shares authorised to be issued, regardless of whether those shares are actually issued, the Authorised Shares Method can lead to very high tax bills for corporations with a large number of authorised shares but relatively low gross assets and issued shares, especially those in high-growth industries. The Delaware Division of Corporations uses the Authorised Shares Method as the default to initially calculate a corporation’s franchise taxes, which can give companies a bit of a shock!

As noted, this method calculates a corporation’s Delaware franchise tax based on the number of shares the corporation is authorised to issue, as follows:

• Up to 5,000 shares authorised: Minimum tax of $175.
• 5,001–10,000 shares authorised: Flat rate tax of $250.
• Each additional 10,000 shares (or portion thereof) authorised: Add $85.
• Maximum annual franchise tax: $200,000.

Assume your corporation has 1,250,000 authorised shares. Here’s how the tax would be calculated under the Authorised Shares Method:

1. First 10,000 shares: $250

2. Next 1,240,000 shares (1,250,000 – 10,000):

• Each additional 10,000 shares incurs an additional $85 of tax
• 1,240,000/10,000 = 124 increments of $85
• Tax for these shares: 124 × $85 = $10,540

3. Total Annual Franchise Tax: $250 (first 10,000 shares) + $10,540 (remaining shares) = $10,790

The Assumed Par Value Capital Method bases the annual franchise tax on a corporation’s issued (as opposed to authorised) shares and total gross assets. The assumed par value is determined by dividing total gross assets by issued shares, with tax assessed at $400 per $1 million of assumed par value, subject to a $400 minimum. It is particularly useful for startups and businesses with a high number of authorised shares but relatively low gross assets.The good news is that, even though the Delaware Division of Corporations initially defaults to the Authorised Shares Method, corporations may choose to use the method that results in a lower tax liability. Therefore, corporations are advised to always calculate their Delaware franchise taxes using both methods and to pay the lower amount. The Delaware Division of Corporations offers detailed information about how to calculate annual franchise taxes under each method here, including a franchise tax calculator.

This method involves more detailed calculations than the Authorised Shares Method, relying on figures for total gross assets, issued shares and the par value of authorised shares. The tax is based on $400 per million dollars of assumed par value capital, with a minimum tax of $400 and the same $200,000 maximum tax as under the Authorised Shares Method.

Assume a corporation having 1,000,000 shares of authorised stock with a par value of $1.00 per share and 250,000 shares of authorised stock with a par value of $5.00 per share, gross assets of $1,000,000 and 485,000 shares actually issued.

1. Divide total gross assets by total issued shares, carrying to 6 decimal places. The result is your corporation’s “assumed par.”
Example: $1,000,000 in gross assets divided by 485,000 issued shares = $2.061856 assumed par.

2. Multiply the assumed par by the number of authorised shares having a par value of less than the assumed par.

Example: $2.061856 assumed par times 1,000,000 shares = $2,061,856.

3. Multiply the number of authorised shares with a par value greater than the assumed par by their actual par value.

Example: 250,000 shares times $5.00 par value = $1,250,000

4. Add the results of #2 and #3 above. The result is your assumed par value capital.

Example: $2,061,856 plus $1,250,000 = $3,311,856 assumed par value capital

5. Calculate your tax by rounding the assumed par value capital up to the next million (if it exceeds $1,000,000), then divide by 1,000,000 and multiply by $400.

• $3,311,856 rounds up to $4,000,000.

• $4,000,000 ÷ $1,000,000 = 4.

• 4 x $400 = $1,600 in annual franchise tax owed

In this same example, you can see that using the Authorised Shares Method would have resulted in an annual franchise tax amount of $10,790!

Note that if you change your corporation’s authorised stock or its par value during the year, the Delaware Department of Corporations will calculate your franchise tax for each period that a specific capital structure was in place. The tax is prorated by multiplying the tax for each structure by the number of days it was active, divided by the total days in the year (365 or 366 for leap years). Finally, all prorated amounts are added together to determine your total franchise tax for the year, ensuring you only pay for the time each structure was in effect.