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Washington D.C. Franchise Tax

The D.C. Unincorporated Business Franchise Tax is imposed on certain unincorporated businesses carrying on or engaging in a trade or business in the District with gross receipts of $12,000 or greater. The tax applies to certain LLC, Partnership and Individuals and is filed on Form D-30. Taxpayers are subject to tax at a rate of 8.25% on net profits, with a minimum tax due of $250. A reasonable salary allowance is allowed for owners to arrive at taxable income.

An unincorporated business carrying on a business in the District and another jurisdiction, must apportion its income among D.C. and the other jurisdiction based on sales.

tax planning for franchises
Full payment of tax is due on April 15th and estimated tax payments are required. Penalties and Interest for late filing or late payment of tax can be severe. You must register for a franchise tax account with the Office of Tax and Revenue (OTR) prior to filing any business tax form.

Most self-employed consultants are exempt from the tax filing requirement if 80 percent of gross income is derived from personal services rendered by the members of the entity and capital is not a material income-producing factor. Thus, many self-employed individuals are able to escape the unincorporated franchise tax as if they were being paid wages. For D.C. resident taxpayers who do owe franchise tax, an adjustment subtraction is available on Form D-40 for income taxed on a franchise tax return. While this avoids double taxation, it may expose a taxpayer to a higher franchise tax rate than he would otherwise pay as an individual.

Rental real estate activities that generate income of $12,000 or greater are required to register and pay the unincorporated franchise tax. Though many rental activities generate tax losses, the minimum payment of $250 is due. Rental properties sold at a taxable gain would also owe franchise tax. In order to apply or maintain your business license for your rental activity, you will have to attest that no taxes are owed to OTR and that the business has “clean hands.”

Corporations (including LLC’s taxed as a corporation) are required to file Form D-20, Corporate Franchise Tax Return and are subject to franchise tax based on a single sales factor and market source rules. This recent change was intended to increase the tax base as D.C. lowers its franchise tax rate in recent years. However, many Corporations are arguably overpaying their Franchise Tax as they may have foreign source contracts that appeal to markets outside of the District.

For District purposes, a Subchapter S Corporation is a C Corporation. Said another way, the District does not recognize the S Corporation flow through for federal tax purposes. A single member D.C. LLC who has elected to be taxed as a separate entity, now is subject to a corporate franchise tax. This entails tax account registration, estimated tax payments, perhaps a higher tax rate and possible double taxation, as Virginia does not allow a credit for franchise taxes paid.

Before establishing your choice of business entity, you should consult a District of Columbia Business Franchise Tax Attorney to evaluation your options and tax liability, particularly if you reside outside the District.

What Is Franchise Tax?

Despite the somewhat confusing name, franchise taxes are not imposed on franchises. Also known as a privilege tax, franchise taxes are paid by corporations, partnerships, enterprises, and other entities which gives them the legal right to provide their products or services within specific states.

While many nonprofits, LLCs, and other fraternal organizations may be exempt from paying franchise tax, some may be liable to pay this tax when they conduct business in a state, despite the company being chartered in a different state.

franchise tax chart

What’s The Difference Between Income & Franchise Taxes?

These are the two main taxes required to be paid by businesses and companies in some states, and if you fail to pay either one of them, your business could become delisted in that state. So it’s important to be aware that there are actually some fundamental differences between income franchise tax. While they are both assessed and due annually, the franchise tax is not included in the total amount due for state and federal income taxes.

One of the most significant differences between them is that the amount of corporate income tax owed will depend on the total profit or net income made by the company or business in that financial year. On the other hand, franchise taxes are not linked to either profit or loss. That means business ventures which run at a loss won’t be liable to pay any income tax at all, whereas franchise taxes will still need to be paid.

What States Require Franchise Taxes?

The total number of states that charge this franchise tax has reduced over the last few decades. Missouri and Pennsylvania first made the decision to completely eliminate the tax, closely followed by Kansas in 2011, and then West Virginia followed suit in 2015.

As of 2020, there are only 14 states remaining who require companies and businesses to pay an annual franchise tax on top of any other state and federal taxes that are due. These states are Texas, Tennessee, Oklahoma, North Carolina, New York, Mississippi, Louisiana, Illinois, Georgia, Delaware, California, Arkansas, and Alabama, as well as Washington D.C.

abstract word cloud for franchise tax with related tags and terms

How Does Each State Assess Franchise Tax?

While each state has its own set of criteria to decide which business entities need to remit franchise taxes, it is usually determined by how the company was initially set up. That being said, most businesses in each state will almost always be liable to pay franchise taxes.

The total amount of franchise tax required from each company is also usually worked out differently too, but most states have set theirs to simple flat rates for various types of businesses. The most common method used by states to calculate the total amount due is based on a few key factors such as the size and type of the corporate entity, and the state it was incorporated.

Some states have their franchise tax rates set as a percentage of combined business assets. Some have based their rate on a percentage of the company’s net worth. Others link it directly to the total dollar amount of business done inside the state, or maybe even of the gross amount of receipts added up over the previous 12 months.

There are also several credits available in each state that can be applied to franchise taxes, which ultimately reduce the total amount of tax owed. For example, companies in Minnesota can take advantage of credits for a range of different things from research and development, to employment of new staff members.

The Bottom Line

Understanding how franchise tax works, how much you have to pay, and how it will affect your company, in general, is super important. The franchise tax in some states is actually quite low, which means it should be fairly easy to pay. Just remember that not only do you need to know how franchise tax works where your business is located, but also any state your company owns property, or that you plan on doing business in. So you may be required to pay a franchise tax in multiple states, rather than just the one.

Anyone who is creating a corporation, company, partnership, or LLC, should contact their state department of revenue to check if your state requires payment of a franchise tax, or if there are any other payments required. Registration is usually done simply by filling out an application for the specific type of business in the state they will be based, as well as any states they intend on working in.