If you are an early stage entrepreneur, you’ve likely already come close to suffering a heart attack, so reading this article (as boring as the title may be) could save your life…or at least prevent you from ruining your day.
For a variety of reasons, Delaware is the preeminent state of incorporation in the United States. Although incorporating in Delaware provides businesses with a myriad of benefits, there is one special thing about Delaware that catches entrepreneurs off-guard every year – determining how to calculate your business’s annual franchise tax. Every year around this time we get calls from a few clients in full freak-out mode, because they received a tax bill from Delaware in the five figures. We hope this overview of the two calculation methods will help ease your stress and simplify your tax season.
Delaware franchise taxes may be calculated in one of the two ways outlined below. The corporation can select which of the two methods it prefers to use, but the State seems to default to the method that yields a larger tax bill (surprise!). Regardless of which method you choose, the tax due will never be less than $175 or more than $200,000.
1. Authorized Share Method
If your corporation has “no par value” stock (which is very, very rare), using the “Authorized Shares” method of tax calculation will result in lower taxes than the “Assumed Par Value Capital Method.” The Authorized Share Method calculates the tax due based on the number of shares authorized (regardless of whether or not those shares have been issued). As you’ll see in the below example, the Authorized Share Method usually results in a higher tax bill for startups, so early stage companies rarely use it.
2. Assumed Par Value Capital Method
Under the “Assumed Par Value Capital” method of tax calculation, the company’s franchise tax is calculated using an assumed par value based on the number of issued shares divided by the company’s gross asset value. The minimum tax applicable under the assumed par value capital method will be $400.00. It is slightly more complicated, but it almost always results in a much lower tax liability for a startup company, and Delaware provides a calculator for taxpayer use.
3. A Prototypical Example
Let’s use a protoypical early stage startup company that has gross assets of less than $1,000,000, with 10,000,000 authorized shares, each with a par value of $0.00001 per share and 3,600,000 shares issued (all common stock).
Under the Authorized Shares Method, the tax due would be $85,165 (gulp), because the company pays $250 on the first 10,000 authorized shares, plus an additional $85 for every 10,000 authorized after that (999 blocks of 10,000 x $85 = $84,915 + $250 = $85,165).
Under the Assumed Par Value Method, the tax due is $400. It would not be fun to write or read the reason, but feel free to use the franchise tax calculator to see for yourself how it works. This is one of the reasons that early stage companies are set up with such miniscule par value on the common stock – it isn’t unusual to see $0.00001 per share or even less!
For more information on Delaware franchise tax, click here for the official state of Delaware information page. If you have questions about your startup company (including franchise taxes), please feel free to reach out to us at [email protected]
Please note – the lawyers at Fourscore Business Law are experienced in business matters of many kinds, which give us the opportunity to be involved in tax discussions on a regular basis. However, we are not CPAs or “tax” lawyers. We have many great contacts and refer our clients to them when needed. Please do not take the summary set forth in this article as tax or business planning advice!
Based in the Research Triangle region of North Carolina, Fourscore Business Law serves entrepreneurs and businesses in Raleigh, Durham, Chapel Hill, Wilmington, Charlotte and throughout the Southeast. We also represent venture capital funds and other investors who invest in companies located in New York, Silicon Valley and everywhere between. The idea of delivering maximum impact in a simple and succinct manner is what we’re calling the Fourscore Principle. And that is what Fourscore Business Law is based on. Our clients operate in a broad range of industries including tech, IoT, consumer products, B2B services and more. Questions? Shoot us an email or give us a call at (919) 307-5356. Your first call is on us.