Jan 162012

Received an absolutely ginormous Delaware franchise tax bill in the past few weeks? Corporate lawyers all across the country are getting phone calls from anxious clients wondering why their startup company now owes Delaware tens of thousands of dollars — sometimes more than their entire company has in the bank.

Take a deep breath — chances are that you don’t owe anywhere close to that much. There are two ways to compute franchise taxes, and Delaware has simply calculated the taxes for what is often the more expensive method, known as the “Authorized Shares Method.” In this method, if you have 5,000 or fewer authorized shares, the franchise tax is $75; if it’s between 5,000 and 10,000, it’s $150; and it goes up by another $75 for every 10,000 shares thereafter.  Note that these are authorized shares, not issued shares. So, a company with, say, a million shares would owe $7,575 under this method.

Luckily, the other “Assumed Par Value” method typically leads to much smaller taxes. In this method, take your gross assets (from your federal tax return) and divide them by the number of issued shares to get your “Assumed Par Value.”  Then, look in your certificate of incorporation for the “par value” of each of your authorized shares (It’s typically very close to $0 — I typically use $0.0001 ) and add them up, BUT if the par value for any share is less than the Assumed Par Value you just calculated, then use the Assumed Par Value.  Divide by $1,000,000, round up, and then multiply by $350.  That’s your new franchise tax. As you can see, the minimum value this way is $350.

Now, it’s possible to really minimize your franchise taxes by only authorizing 5,000 shares and using the Authorized Shares method — that reduces it from $350 down to $75. But, 5,000 shares isn’t much, especially if you want to grant stock options or seek investors. At that point, the money you spend increasing the number of shares probably eclipses the $275 you save in franchise taxes.

Fair warning here: one mistake that I’ve seen lay people make, especially when they try to save money by using forms they found on the internet or using one of those “we’re not attorneys, we just help you fill out and file your forms” services, is to create their shares with no par value. That’s completely legal under Delaware law, but without par values, the assumed par value method isn’t available.  And that can turn a $350 tax bill into a $7,575 bill.

[Graphic courtesy of DonkeyHotey on Flickr.]