Considering forming an LLC or corporation in the state of Delaware?
There are many reasons that companies form in Delaware.
One thing that attracts many of our clients is the lack of income tax for corporations and LLC’s. But what many entrepreneurs don’t know is that there is a franchise tax. That is, there is a yearly minimum tax due, no matter what.
And for a new business, it can be substantial.
So much is this franchise tax? Let’s break it down…
There are two methods of calculating the franchise tax amount in Delaware: the “Authorized Shares Method” and the “Assumed Par Value Capital” method. You pay the lesser of the two approaches.
Say your corporation authorizes 100,000 shares. By the “Authorized Shares Method” of calculation, the annual franchise tax will be $825.
If you authorize 100,000 shares, the franchise tax is $7,575.
If you use the Assumed Par Value Capital method, it may be less, but this depends on what you’ve set your per share par value to.
A Example Case:
An accountant recently told us of a startup that planned to form in Delaware. They were going to issue 10 million shares to the founders, form a stock option pool of another 10 million shares, then sell another 10 million shares to investors at a value of $5 per share.
Sounded like a solid plan to the entrepreneurs until the CPA ran the numbers on the franchise tax. The “Authorized Shares Method” for 30 million shares authorized calculates a tax bill of $180,000 per year.
By the Assumed Par Value method, its less, but still substantial: $17,500.
Once the CPA explained this to them, they changed their plans and formed in California, where the business was based, and saved a ton of capital right out of the gate.
So consider this franchise tax before jumping at forming a corporation or LLC in Delware. Talk to us. We’re here to help with your questions.
And also, as always, talk to your accountant. If you don’t have someone that you’re working with, contact us, and we’ll refer you to several top quality CPAs to speak with.