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The Delaware Franchise Tax can be a sticker shocker if you have not planned your capitalization
 properly, or if you are not aware that there are two methods allowed to compute the franchise tax.
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Watch Out For Those Franchise Taxes
by Anthony Nassar

If incorporating your business in Delaware is in your future plans, this article may help you save thousands of dollars.

The Delaware Franchise Tax can be a sticker shocker if you have not planned your capitalization properly, or if you are not aware that there are two methods allowed to compute the franchise tax.

When you receive your Delaware Annual Report, you may see a significant amount of tax due - don't panic just yet. You might be able to compute your tax using a different method which could result in a substantially lower number. The tax is due by March 1, with a current quarterly installment requirement for taxpayers owing more than $5,000.

As of the date of this article, there are two methods allowed for the computation of the Delaware Franchise Tax:

1-     the Authorized Shares Method

2-     the Assumed Par Value Capital Method

In the Authorized Shares Method, you only use the number of authorized shares to compute the tax.  In the Assumed Par Value Capital Method, you must also use all issued shares, the par value, and your company’s total gross assets (as reported on the U.S. Form 1120, Schedule L, or your federal corporate tax return.)

The website for the State of Delaware offers a clear explanation of how these two methods work (visit http://www.state.de.us/corp/frtaxcalc.shtml.) It also includes an excel spreadsheet that estimates the tax based on your parameters for 2003 (visit http://www.state.de.us/corp/taxcalc2003.xls). If you are reading this article several months or years from now (Feb. 2004), please check that the above due dates and links are valid and applicable to the calendar year you are interested in analyzing.

Below is an example illustrating how, for the same company, the Authorized Shares Method can result in a franchise tax of $68,800 as compared to $500 for the Assumed Par Value Capital Method.

Let us consider the case of a start-up, which for the entire 2003 year had 7,000,000 issued shares and 10,000,000 authorized shares of common stock respectively, with a par value of $.01. It also had 1,000,000 in issued and authorized shares of Series A Preferred Stock with a par value of $.01. Its total gross assets as of 12/31/2003 were $1,000,000.

Using the calculator provided on the website of the State of Delaware, the estimated tax is:

$68,800 for the Authorized Shares Method

$500 for the Assumed Par Value Capital Method, and you are allowed to select this method to compute your tax liability.

What caused such a big difference was the company’s choice to assign a par value for its stock, and the careful selection of that par value in addition to the relatively small magnitude of its total gross assets. Without the par value, the company’s tax liability would be $68,800 - not a trivial expense.

If you like to play what-if-scenarios with spreadsheets, I suggest you open the calculator and input the above parameters, then start changing the number of shares, the par value, and the total gross assets. You'll notice that the tax amount will fluctuate dramatically all the way up to the maximum tax for 2003 of $165,000.

Please click to see a table illustrating the sensitivity of the tax to the various parameters. The numbers in yellow correspond to the parameters I have modified from the above example and the resulting updated tax amounts for each method.

I strongly recommend that you retain the services of a law firm that has expertise in the area of incorporation in Delaware before you file your certificate of incorporation and restate it. A minor oversight in your capital structure can end up costing you considerable franchise tax dollars unnecessarily.  

Please note that the above figures are for illustration purposes only. As mentioned earlier, they can vary widely depending on the number of shares issued and authorized for each class of stock, the par value for each class of stock, and the amount of total gross assets. Again, please seek the advice of a qualified attorney for your specific situation.

This article was first published in the February 2004 issue of our e-zine, Propel Your Venture.

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Disclaimer: The information in this article (the "Information") is current as of February 2004.. The Information is intended solely to illustrate general concepts and guidelines on various business subjects. It may not apply to specific situations. The Information does not constitute accounting, financial, tax, legal or other professional advice. You are urged to consult with a qualified professional who can understand your specific situation and advise you accordingly. No Information creates a warranty. All Information and links to other websites are provided on an ‘as-is’ basis without any warranties, express or implied, including warranties of merchantability or fitness for a particular purpose. In no event shall Venture Momentum, Inc., its authors, publishers, contributors and editors be liable for any indirect, incidental, special, consequential, or punitive damages of any kind whatsoever arising out of your use of this article,  the Information, and/or links to other websites regardless of the cause of action.
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