No, You Don’t Owe Delaware $200,000. — DE Franchise Tax 101
Around this time of year, I always get a note from a panicked startup company that has logged in to pay their annual Delaware franchise tax and has seen an eye-watering number.
While it’s true that every year you will have to pay our good friends in DE for the pleasure of existing (death and taxes being the two certainties in life), it is also true that DE is not in the habit of bankrupting its fledgling companies with onerous franchise tax bills.
In a nutshell, DE lets a company calculate its franchise tax using one of two methodologies, and the company gets to pay the lower of the two.
These methods are the Authorized Shares Method and the Assumed Par Value Capital Method.
Under the Authorized Shares Method, the tax is based solely on the number of shares a corporation is authorized to issue, as stated in its certificate of incorporation. The more authorized shares, the higher the tax. Obviously, this would result in an incredible franchise tax bill for a startup, since startups normally have tens of millions of authorized shares. Unfortunately for fast-moving founders, this method is what DE uses to auto-populate the “pay now” page on the DE website when you log in to pay your franchise tax, giving you that ice-cold, stomach-drop feeling of seeing a massive and unexpected tax bill.
But now you know the story does not end there. You can simply select to use the Assumed Par Value Capital Method (APV) method, which instead bases the tax on a proxy for the corporation’s invested capital. In brief, it looks to the corporation’s total gross assets, apportions those assets per share of issued stock, and then derives an “assumed par value capital” figure on which the tax is assessed. Because the APV calculation incorporates actual issued shares and balance-sheet assets rather than merely the larger authorized number, it will almost always produce a lower tax for early-stage companies. DE will do this calculation for you through their franchise tax filing website if you provide the required inputs (most importantly, your gross assets, which should either match your Form 1120, Schedule L of that year’s federal tax filings, or a recent balance sheet).
Importantly, if you will use the APV method, you should have issued around half (or more) of your authorized shares. If you have a large number of authorized shares but have issued very few of them, the APV calculation may result in a large tax liability.
Finally, Delaware law also provides statutory minimums and maximums (including special rules for “large corporate filers”) that can cap or floor the tax liability regardless of the chosen method. When planning, corporations should confirm the current-year thresholds and due dates in the statute and related guidance, and ensure they are prepared with the inputs needed to calculate the APV in advance of the March 1 annual filing deadline.
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