Don’t Panic! Your pre-revenue startup doesn’t owe $85,165 in Delaware Franchise Taxes
It’s Delaware Franchise Tax Season! If you’re incorporated in Delaware and you’re staring at a terrifying notice with the number $85,165.00 on it, don’t panic. It’s very likely that your startup only owes $400. Read on for details on how to refigure your bill, easily file your report, and reduce your stress in future years.
Don’t panic, refigure
It’s a shockingly large number so first things first, let’s refigure your bill. Grab the number of authorized shares and par value from your startup’s articles of incorporation, the number of shares you’ve issued from your cap table, and your startup’s gross assets from your books and head over to the Delaware Franchise Tax Calculator from our filing partners over at HBS. Plug in your info and take a sigh of relief. Better? Ok, now let’s get into the details…
What are franchise taxes and how do I file?
If you’re a startup incorporated in Delaware–as you should be if you have big aspirations–you’re required to file an annual report and pay a yearly franchise tax by March 1st. Your annual report and franchise tax payment buy your startup the privilege of doing business in Delaware and utilizing the state’s court system. Aside from having to navigate a government website, the process is relatively straightforward and inexpensive–here are detailed instructions in written and video form. Despite the simplicity of filing, Delaware Franchise Tax consistently induces a wave of panic for founders every single year. Why? The estimates.
Eye-popping estimates
Prior to the March 1st deadline, your startup’s registered agent–the entity responsible for being your official point of contact in Delaware–is required to send you a notice of your startup’s obligation to file an annual report and pay franchise tax. This notice typically contains the dollar amount of franchise tax that has been assessed for your company. If your startup has authorized 10M shares, as many do, you’re likely to receive the eye-popping estimate of $85,165.00. While this assessment is technically correct, there’s a twist: Delaware allows two methods of calculating franchise tax.
It’s not exactly surprising that a taxing authority would communicate using the higher of the two calculations but, in this case, it seems pretty illogical. Delaware has no realistic expectation that a pre-revenue startup can foot this bill and they’re invested in preserving their reputation as an exceedingly business-friendly state. On top of that, your registered agent dreads the customer support nightmare that follows these notices. So, if there’s a more reasonable calculation, why communicate using this panic-inducing number? The answer is surprisingly simple.
Decoding the calculation methods
There are two methods to calculate Delaware Franchise Tax: the Authorized Shares Method and the Assumed Par Value Capital Method. The Authorized Shares Method is based on–you guessed it–the number of authorized shares in your company. It uses the number of authorized shares as a rough proxy for the size and complexity of the company. Since many startups authorize a very large number of shares (10M is exceedingly common) using this method results in a very large franchise tax assessment that is not aligned with the actual size and complexity of the enterprise.
The Assumed Par Value Capital method is generally more startup friendly, often reducing the franchise tax assessment to the minimum for corporations: $400. The Assumed Par Value Capital method calculates franchise tax based on the par value of a company’s shares, the ratio of issued to authorized shares, and the company’s actual assets. It leverages additional information about the enterprise to build a more precise estimate of its size and complexity.
A matter of missing information
See the catch? While the Assumed Par Value Capital method is obviously the better choice for startups, calculating the tax assessment using this method requires information that the state of Delaware and your registered agent don’t have access to.
Since the Authorized Shares Method is calculated solely based on information your startup provided to Delaware when it filed its articles of incorporation, that’s the method used in official communication. Nobody wants to be held liable for providing an inaccurate estimate based on information they don’t have access to.
At the end of the day, Delaware Franchise Taxes are relatively straightforward to navigate once you get over the sticker shock and have a decent understanding of what’s going on behind the scenes. While you’ll probably want an accountant to help with other tax obligations, this is one most entrepreneurs can knock out themselves in the early stages. If you’re looking for support handling franchise tax, early legal, and operations Gust provides software and support to help you stay on top of the easy stuff, recognize the strategic stuff, and connect with the best experts to help when it’s time.
Gust Launch can set your startup right so its investment ready.
This article is intended for informational purposes only, and doesn't constitute tax, accounting, or legal advice. Everyone's situation is different! For advice in light of your unique circumstances, consult a tax advisor, accountant, or lawyer.