Delaware Franchise Taxes 101.

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Delaware Franchise Taxes 101.

Sometimes, about January, I get an urgent call from a founder telling me that his or her corporation has received a franchise tax bill from the State of Delaware for tens of thousands of dollars.  Sometimes the founder will even reproach me for having advised him or her to incorporate in Delaware.  I always have good news: The taxes due are actually tens of thousands of dollars less.  In fact, for newly formed start-ups with assets of little or no value, the taxes due are generally less than $1,000.00.

Corporations incorporated in Delaware are generally required to pay franchise taxes and file an “annual report” each year.  The State of Delaware sends corporations’ Delaware registered agents notifications of franchise taxes and annual reports due in December of each year.  Delaware registered agents generally distribute these notifications to corporations by January.  Payment of the franchise taxes and the completed annual reports are due no later than March 1.

The State of Delaware’s default method for calculating franchise taxes is the authorized shares method, and the taxes due in the notification are calculated using this method.  Under this method, a corporation’s franchise taxes are based on the number of authorized shares in the corporation’s certificate of incorporation as of December 31:

1.    $75.00 for 5,000 or less authorized shares.  (Thus, the minimum franchise tax under this
method is $75.00.)

2.    $75.00 for 5,001 to 10,000 authorized shares.

3.    Plus $75.00 for each 10,000 authorized shares, or portion thereof, in excess of 10,000
authorized shares.

4.    The maximum tax using this method is $180,000.00.

Alternatively, the State of Delaware allows a corporation to calculate its taxes using the assumed par value capital method.  Under this method, a corporation’s franchise taxes are calculated based on the number of authorized shares in the corporation’s certificate of incorporation, the number of issued shares and the corporation’s gross assets as of December 31 as follows:

1.    Divide the corporation’s total gross assets by the corporation’s total issued shares (i.e., the
corporation’s total outstanding shares plus any treasury shares).  This quotient is the
“assumed par value.”

2.    Multiply the corporation’s total authorized shares by the greater of the shares’ par value
(set forth in the corporation’s certificate of incorporation) and the assumed par value.  This
product is the “assumed par value capital.”

3.    The franchise taxes due are $350 for every $1,000,000, or portion thereof, of assumed par
value capital.  (Thus, the minimum franchise tax under this method is $350.00.)

4.    As with the authorized shares method, the maximum franchise tax using this method is
$180,000.00

Things can get a little complicated under the assumed par value capital method if different classes of shares have different par values.  And things get even more complicated under both methods if a corporation’s certificate of incorporation has been amended to change the number authorized shares or the shares’ par value during the course of the year.  In such cases, the taxes are calculated by obtaining a weighted average of the taxes due as of the date of each amendment and December 31.

Corporations set up to receive angel, venture capital or strategic financing typically have at least 10,000,000 authorized shares.  Such corporations – even those that have conducted one or more financings and have significant assets – can often-times achieve a significantly lower tax bill using the assumed par value capital method.

The State of Delaware’s website provides more details, including example tax calculations and a tax calculator.  Some entrepreneurs calculate the taxes themselves, but others have them calculated by their Delaware agent, their accountant or even their lawyer.  Regardless of who performs the actual calculation, founders should always check to see if using the assumed par value capital method will result in a lower tax bill.