One of the most misunderstood and misused terms in taxation is “franchise tax.” A franchise tax is simply a tax on the right to do business in a state, city, or county. Confusion arises because many states call their income taxes franchise taxes.
Minnesota calls its corporate income tax a franchise tax, but in reality it is an income tax because it is imposed on taxable incomes. There are 25 states that levy true franchise taxes on corporations in addition to income taxes. Franchise taxes are usually computed on a company’s equity or capital structure.
The 50-State Comparison highlights which states levy a franchise tax on businesses.
Individuals in many states also pay franchise taxes. The most common franchise tax appears as an excise tax on a utility bill. The tax is usually a flat percentage of a gas, electric, water, phone or cable bill. Rates vary per jurisdiction, but they average around 3% and can run as high as 7%.
To demonstrate, say you have a $100 monthly electric bill before taxes in a city with a 3% franchise tax. You would be charged $3 for the franchise tax then the sales tax would be imposed and computed on the $103 base. There are typically no exemptions (even government must pay the franchise tax) on utility franchise taxes as the franchise tax is levied on the utility provider which in turn is allowed to pass the cost on to the consumer. Utility franchise taxes are common in both Iowa and Nebraska.
We can count ourselves lucky that we’re not aware of franchise taxes, as they don’t exist in South Dakota. Whether you’re billed directly for a franchise tax or a business pays a franchise tax, it is ultimately the final consumer who ends up paying the tax.