A founder picks a state on the strength of a low filing fee, forms the company, and eleven months later receives a bill for several hundred dollars from an authority they have never heard of. The company made no money. The bill is still due.
Franchise tax is the most consistently misunderstood running cost of a US company, starting with its name. It has nothing to do with franchises, it is usually not based on profit, and it is the single largest reason the cheapest state to form in is not always the cheapest state to stay in.
What the tax is actually charging for
Income tax charges you on what you earned. Franchise tax charges you for existing as a registered entity in that state — for the privilege of holding the registration and the legal protections that come with it.
Once you see it that way the rest follows. The state provides a legal structure, a public register, courts that will recognise your entity. That service has a price, and the price does not depend on whether you used the structure to make money this year.
This is why "my company was dormant" is not an argument that works. The registration existed for the whole year, which is the thing being charged for.
How states calculate franchise tax, and why it varies
There are four broad approaches, and knowing which one a state uses tells you far more than the headline number.
- A flat annual amount. The simplest. Every entity pays the same regardless of size, which is predictable and is usually the cheapest for a small company.
- Based on capital, shares or assets. Common for corporations, and it means the bill grows with the balance sheet rather than with profit. A company holding cash can owe more than one that spent it.
- Based on gross receipts. This charges on revenue before costs, which is the harshest basis for a low-margin business. A reseller turning over a large sum on thin margins can owe substantially more than a consultancy earning more profit on less revenue.
- A minimum with a calculated amount above it. You pay the greater of a floor and a formula, which is why small companies in these states all pay exactly the minimum.
The states that matter most to foreign founders
| State | Broad treatment | What to watch |
|---|---|---|
| Wyoming | An annual report fee based on assets located in the state | Low for a company with no Wyoming assets, which is most foreign-owned ones |
| New Mexico | No annual report and no franchise tax of this kind for LLCs | Cheap to maintain, but weigh the other trade-offs |
| Delaware | A flat annual tax for LLCs, separate from corporations | Predictable, and the corporation calculation is entirely different |
| California | A substantial annual minimum | Applies to companies merely doing business there, not only those formed there |
| Texas | Based on margin, with a no-tax-due threshold | Small companies often owe nothing but must still file the report |
| New York | A filing fee scaled to income, plus publication requirements | The one-off publication cost surprises people more than the tax |
The California row deserves particular attention, because it is the trap most often fallen into. The obligation can attach to a company that is doing business in California even though it was formed in Wyoming or Delaware. Forming elsewhere does not avoid it if the activity is there.
The calculation that changes the answer
Founders compare states on the formation fee, which is paid once. The comparison that matters is the total over the life of the company.
Consider a company formed for a hundred dollars in a state with a three-hundred-dollar annual obligation, against one formed for three hundred in a state with a fifty-dollar annual obligation. The first looks two hundred dollars cheaper on day one. By the end of year two the second is ahead, and by year five it is ahead by nearly a thousand.
Add the registered agent, which you pay in either case, and the annual figure is what dominates. Almost nobody forms a company intending to close it within a year, so the running cost is the number that should drive the decision.
Two obligations that arrive together and are not the same
States commonly require an annual report alongside the tax, and the two get conflated because they usually share a deadline.
The annual report is an information filing: confirming the registered agent, the address, sometimes the members. Its purpose is keeping the public register accurate.
The franchise tax is a payment.
Some states combine them into one submission with one deadline, which is convenient and is also why founders assume paying one satisfies the other. Where they are separate, filing the report and forgetting the payment leaves the company delinquent while the founder believes everything is done. Check whether your state treats them as one item or two, and diarise accordingly. What happens when you miss it is covered in what happens if you miss your LLC annual report.
What non-payment actually escalates to
This is not a bill that quietly accumulates in a drawer. The progression is fairly consistent across states.
- Interest and penalties begin accruing from the due date.
- Loss of good standing. The company is still registered but is flagged. This is the point at which banks and payment processors notice, because a certificate of good standing can no longer be issued.
- Notices to the registered agent. If the agent has lapsed as well, these go nowhere.
- Administrative dissolution. The state ends the registration.
- Loss of liability protection for the dissolved period, which is the consequence that actually matters.
Reinstatement is usually possible and involves back taxes, penalties and a filing fee. It is always more expensive than paying on time, and the gap in the company's history remains on the public record.
Registering in a second state doubles this
A point that catches growing companies. If activity in another state requires you to register there as a foreign entity, you now have two registrations, two registered agents, two annual reports and potentially two franchise tax obligations.
That is not an argument against expanding. It is an argument for knowing the cost before you trigger it, because the trigger is usually an ordinary commercial decision — hiring someone, taking an office, holding inventory — made without reference to the filing consequences. The mechanics are in foreign qualification.
Budgeting realistically for year one and after
For a straightforward foreign-owned LLC in a low-cost state, a realistic annual figure is roughly $50 to $200 for the state obligation, $50 to $300 for the registered agent, and $100 to $400 for a business address. Call it $200 to $900 a year before any accounting fees.
Year one is higher because the formation fee lands as well. Where founders get caught is year two, when the formation excitement has passed, the company may not yet be profitable, and a bill arrives for a company that feels dormant.
Set the money aside in month one. It is a known, dated, unavoidable cost, and it is the least stressful bill in the business to plan for.
Choosing a state on the right criteria
The state question generates enormous online debate, most of it focused on privacy and prestige. For a small foreign-owned company the practical ranking is:
- Total annual cost, because you pay it every year for as long as the company exists.
- Whether you will have to register elsewhere anyway, which can make the original choice largely irrelevant.
- Administrative simplicity — some states are markedly easier to file with from abroad.
- Privacy, which matters to some founders and is genuinely different by state.
- Prestige, which matters almost exclusively if you intend to raise institutional investment.
Most founders reading this are optimising for the first three and being sold the last two. The comparison is set out in Wyoming vs Delaware vs New Mexico and the wider cost picture in what a US LLC actually costs state by state.
Why the name confuses everyone
It is worth addressing the terminology directly, because the confusion it causes is not trivial — founders search for guidance, find material about franchising, and conclude the tax cannot apply to them.
The word franchise here carries its older legal sense: a right or privilege granted by a government. A franchise tax is a charge for the privilege the state has granted you, which is the right to operate as a limited liability entity under its law. Nothing about business format franchising is involved.
The confusion is compounded by the fact that states use different names for substantially the same thing. What one calls a franchise tax another calls an annual report fee, a business privilege tax, a margin tax or simply an annual tax. Two states can charge an almost identical amount on an almost identical basis and describe it in ways that sound unrelated.
The practical lesson is to ignore the label when comparing states and ask the same three questions everywhere: what is the annual amount, what is it calculated on, and is a separate report required alongside it. Those three answers are comparable across states in a way the names are not.
What happens when you form late in the year
A detail that produces an unwelcome surprise for anyone forming in the closing months of a year.
Many states tie the obligation to the calendar or fiscal year rather than to how long your company has existed within it. A company formed in November can owe the full annual amount for that year, with the next year's amount falling due only a few months later. Two bills in quick succession, for a company that has existed for a matter of weeks.
Some states prorate and some do not, and the difference is rarely prominent in the formation material you read before filing. If you are forming in the last quarter of a year and the amount involved is material to you, it is worth checking directly whether the first year is prorated. Where it is not, delaying formation until January can save an entire year's charge for the cost of a few weeks' patience — and where the company is not yet trading, that patience costs nothing at all.
If the bill has already arrived and you cannot pay it
Do not ignore it, and do not assume a dormant company is a defence. States are generally more accommodating than founders expect when contacted early.
File the return or report on time even if you cannot pay the amount, because the penalty for failing to file is usually separate from and larger than the penalty for paying late. Then contact the state about a payment arrangement. Many offer them, and entering one usually stops the escalation towards dissolution.
If the company genuinely has no future, closing it properly is cheaper than letting it be dissolved. Walking away leaves the obligations outstanding against the entity and, in some states, can leave exposure attaching to the people behind it. The process is covered in dissolving a US LLC from abroad.
The short version
Franchise tax is a charge for existing, not for earning. Dormant companies usually still owe it. The basis of calculation varies enough between states that the headline number tells you little on its own. And the cheapest state to form in is frequently not the cheapest state to keep a company in for five years.
Work out the annual cost before you file rather than after, set the money aside in month one, and diarise the deadline independently of any letter arriving. If you would rather have this planned properly from the start, it is part of our formation service.
If you would rather have this handled for you, our US LLC formation service covers it end to end. For the official position, see Delaware Division of Corporations: franchise tax.