The Startup Guide to Navigating the Delaware Franchise Tax
The Startup Guide to Navigating the Delaware Franchise Tax

January 31, 2024

Accounting & Finance, For Startups

The Startup Guide to

Navigating the Delaware Franchise Tax

Michael Smith

Michael Smith, Managing Director of Taxes at Graphite

Many startups are registered in Delaware due to its business-friendly laws, but that doesn’t mean that everything is smooth sailing. There are a handful of state-specific policies you must adhere to, the most elusive of which is the Delaware Franchise Tax.

If you want to remain in good standing, this is a crucial concept to understand. 

But that doesn’t mean it’s completely straightforward, so that’s what we’re here to help with. Whether you’re a seasoned business veteran or a brand-new entrepreneur, these next 1,000 words should simplify and clarify what the Delaware Franchise Tax process is all about.

What Is the Delaware Franchise Tax?

The Delaware Franchise tax is an annual tax imposed on corporations that are incorporated in the state of Delaware. It’s mandatory for all Delaware corporations, whether they do business within the state or not.

This tax is distinct from income tax and is not based on income or profits. Instead, it’s based on a company’s authorized shares or assumed par value capital.

The purpose of the tax is, in light of the many businesses opting to do business here for the tax benefits, to grant the privilege of operating as a legal entity within the state.

When Is the Delaware Franchise Tax Due?

This tax is due annually by March 1st. 

If a corporation fails to pay the tax by this deadline, the state of Delaware imposes a late penalty of $200. Additionally, an interest rate of 1.5% per month is applied to the unpaid tax balance. These penalties and interest will continue to accrue until the full payment of the tax is made.

How to Calculate the Delaware Franchise Tax

You can calculate your Delaware Franchise tax in two ways—the Authorized Shares Method and the Assumed Par Value Capital Method. 

The tax will ultimately be determined by whichever of these calculations results in the lesser amount. So we’d recommend doing both calculations to make sure you’re not paying more than you need to.

Authorized Shares Method

This method is based on the number of shares a corporation has been authorized to issue. Here is the breakdown:

  • For up to 5,000 authorized shares, the minimum tax is $175.
  • For 5,001 to 10,000 authorized shares, the tax is $250.
  • For each additional 10,000 authorized shares, $85 is added to the tax amount.

For example, if a corporation has 25,000 authorized shares, the tax amount would be calculated as follows:

  • $250 for the first 10,000 shares
  • Plus $170 ($85 x 2) for the additional 15,000 shares, since it is calculated in increments of 10,000 
  • Leading to a total tax liability of $420

Assumed Par Value Capital Method

This method of calculation takes into account the actual value of a corporation’s shares and total gross assets. 

  • Start by calculating the total value of assets owned by the corporation.
  • Then, calculate the Assumed Par Value by dividing the gross assets by the number of total issued shares, carrying the number to six decimal places. 
  • Calculate the Assumed Par Value Capital by multiplying the Assumed Par Value by total authorized shares.
  • Since every $1,000,000 is taxed $400, divide the Assumed Par Value Capital by $1,000,000. Round the calculation you get up and multiply it by $400 to determine your tax amount. 

Let’s walk through an example of how this would look in practice for a company that has 150,000 authorized shares, 50,000 total issued shares, and $1,500,000 in gross assets.

  • You determine that your total gross assets are $1,500,000
  • Assumed Par Value: $1,500,000 (total gross assets) / 50,000 (total issued shares) = $30
  • Assumed Par Value Capital: $30 (Assumed Par Value) x 150,000 (authorized shares) = $4,500,000
  • Applying the effective tax rate: $4,500,000 / 1,000,000 = 4.5
  • Round up to 5 and multiply by $400 = $2,000

Need to get your taxes in line to make sure you’re compliant?

Common Misconceptions and Mistakes

One of the primary misconceptions about this tax is due to its name. Despite the presence of the word “franchise,” franchise businesses are not the only ones subject to this tax. All businesses that are registered in Delaware—regardless of their operational base and whether they’re actively generating income or not—are on the hook. 

Another common misconception is that all businesses need to pay the same amount. In reality, the tax amount varies significantly based on the company’s structure, assets, and the number of shares issued. A blanket approach to estimating the franchise tax can lead to miscalculations and potential legal issues.

And perhaps the most common mistake has to do with the calculation method used, as mentioned above. The Delaware Franchise Tax website automatically defaults to the larger number, so that’s why it’s important to have expert guidance when calculating what your startup owes. Many startups end up overpaying due to not doing both calculations and paying the lesser of the two. In some cases, the difference can be significant. 

And finally, it’s important to note that this tax is separate from your annual registered agent fee. 

Is the Tax Worth the Benefits for Startups?

Due to this additional tax, many startups may question whether it’s worth it to register in Delaware, as a company based in another state. In general, this small fee is negligible compared to the benefits.

Delaware has a pro-business legal system, which is often held up as the best in the country. It has an extensive body of corporate law and a specialized court, the Court of Chancery, dealing primarily with business disputes. This can provide security for startups and their investors, knowing that they are operating within a well-established legal framework.

Startups also benefit from the prestige associated with being a Delaware-incorporated company. Many investors and Venture Capitalists prefer investing in Delaware corporations due to their familiarity with the state’s corporate laws. This can make it easier for startups to attract investments, which is crucial in their early stages of development.

Delaware’s franchise tax structure is often beneficial for startups, too. The companies that don’t conduct business in the state can avoid income tax. Since this income tax typically eats up a large chunk of profits, the franchise tax seems like pennies compared to the money that startups are saving. 

Stay On Top of Any Taxes Coming Your Way

The Delaware Franchise Tax is far from the only tax that your startup may be on the hook for. It’s important to be proactive and stay in front of these deadlines. 

Failure to pay taxes can bring extra fees that could be better spent investing back into the business. Not paying taxes can also cause compliance issues. 

But we get it, you’ve got a million things on your plate, so adding taxes as another thing to check off your endless to-do list is the last thing you want. 

We’ll catch every tax that may be easy to fly under the radar, and most importantly, identify all of the ways that you can reduce your tax obligations. So if you want to stay compliant while making sure that you’re not overpaying, learn about the tax compliance services we provide at Graphite. 

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