The difference between franchise tax and income tax – a comparison of business taxes
States impose both franchise taxes and income taxes. They differ in how they relate to a business’s operations within a state, known as nexus. Lets explore the distinctions between the two.
Taxable Entities
Franchise Tax
his tax is applied for the privilege of conducting business activities within a state regardless of whether the business is profitable or not.
Income Tax
Businesses are taxed on the profits they generate within a state.
Criteria for Nexus
Franchise Tax Nexus
Establishing nexus for franchise tax purposes generally requires criteria compared to income tax nexus. Simply owning property having employees or engaging in sales activities within a state could be sufficient to trigger franchise tax obligations based on that states regulations.
Income Tax Nexus
Historically establishing income tax nexus necessitated a physical presence, in the state. This might include maintaining an office having employees working there or storing inventory within the state boundaries. Lately there has been an increased focus on the concept of ” nexus.” This concept allows states to levy income tax on businesses that have a tie to the state even if they don’t have a physical presence there.
Here’s a summary table highlighting the variances
| Feature | Franchise Tax | Income Tax |
|---|---|---|
| What it taxes | Privilege of doing business | Profits earned |
| Based on profit | No | Yes |
| Nexus Standard | Lower | Higher (traditionally), but economic nexus is expanding |
Nexus and Compliance
Having a clear understanding of nexus is vital for businesses that operate in multiple states. If your business has nexus in a state you are required to file and potentially pay the tax (franchise or income). Here’s how nexus can impact compliance;
Franchise Tax
Even if a business has activity in a state with a franchise tax it may need to register and possibly pay the tax regardless of its profitability.
Income Tax
Businesses with presence or significant economic activity in a state could be subject to income tax, on profits generated within that state.
Key Points to Remember
The rules regarding nexus can differ greatly depending on the state. The Supreme Courts ruling in the Wayfair case in 2018 brought about changes in nexus for sales tax, which subsequently influenced income tax nexus as well leading many states to adopt broader economic nexus criteria.
Understanding the differences, between franchise tax and income tax nexus enables businesses to navigate the complexities of state taxation effectively and stay compliant with laws.
We’re tax experts and we’ll help you avoid the hassle of nexus taxation.
