As a technology startup incorporated in Delaware, you will receive a tax bill from the State of Delaware. It isn’t necessarily tied to income, but it is a tax you need to pay because the company’s place of origin is in the State of Delaware. All active corporations incorporated in Delaware must pay the annual franchise tax on or before March 1st. This is a franchise tax, not an income tax.
For first time founders, I often get a panicked email or call about their first bill being as much as $150,000 when they are still pre-revenue or pre-launch. Here’s the deal – as described below, there are two methods of calculating your Delaware tax liability and the method that Delaware chooses for you by default (the Authorized Shares Method) will usually result in a panic-creating large tax bill.
Here’s the key: you can use either the Authorized Shares Method or the Assumed Par Value Capital Method to calculate your tax bill. Obviously, use the method that results in the lesser tax. Unfortunately, Delaware will by default send you a tax bill using the Authorized Shares Method which could be about $150,000 for most technology startups with a standard Certificate of Incorporation with about 20,000,000 shares authorized.
Authorized Shares Method
- 5,000 authorized shares or less (minimum tax) = $175.00 tax.
- 5,001 to 10,000 authorized shares = $250.00 tax.
- each additional 10,000 shares or portion thereof add $75.00
- maximum annual tax is $180,000.00
For example, a startup with 10,005 authorized shares pays $325.00 ($250.00 plus $75.00). Or, a startup with 100,000 authorized shares pays $925.00 ($250.00 plus $675.00 [$75.00 x 9]). The problem with this method is that in the technology startup world, most startups are incorporated with 15 to 20 million authorized shares. With 20 million authorized shares, you would get a bill for $150,175.00 even if you haven’t sold a single subscription. Don’t pay this amount! Most startups should recalculate the tax bill using the Assume Par Value Capital Method described below.
Assumed Par Value Capital Method
This method uses the total gross assets reported on the U.S. Form 1120, Schedule L of the company federal return. Using the Assumer Par Value Capital Method you will need the following numbers:
- Total gross assets
- Total issued shares
- Total authorized shares
- Par value of the shares stated on the Certificate of Incorporation which is $0.001 per share for most tech startups
Here are the steps (don’t get too overwhelmed with this calculation – here is a Delaware Franchise Tax Calculation spreadsheet for you to plug in numbers to calculate both methods):
- Calculate your assumed par value by dividing your total gross assets by your total issued shares (carrying to 6 decimal places).
- For any authorized shares with a par value of less than the assumed par value (which will be ALL the authorized shares for most technology startups since the par value is usually set at $0.0001 per share), multiply the assumed par value by the number of authorized shares.
- For any authorized shares with a par value greater than the assume par value, multiply the number of authorized shares by their respective par value.
- Add the two numbers up from #2 and #3, and this is your assumed par value capital.
- Round the assumed par value capital up to the next million dollars.
- Divide this rounded number by 1,000,000 and multiply by $350. This is your tax bill.
Here’s an example given on Delaware’s website: A corporation has 1,000,000 shares of stock with a par value of $1.00 and 250,000 shares of stock with a par value of $5.00, gross assets of $1,000,000.00 and issued shares totaling 485,000.
- Assumed par value = $1,000,000 assets divided by 485,000 issued shares = $2.061856 assumed par.
- There are 1,000,000 shares authorized with a par value of less than the assumed par value ($1 is less than $2.061856). So, $2.061856 assumed par value multiplied by 1,000,000 authorized shares = $2,061,856.
- There are 250,000 shares authorized with a par value greater than the assumed par value ($5.00 is greater than $2.061856). So, multiply $5.00 par value by 250,000 authorized shares = $1,250,000.
- Assumed par value capital = $2,061,856 plus $1,250,000 = $3,311 956 assumed par value capital.
- Round up to the next million = $4,000,000 assume par value capital.
- Tax bill = $4,000,000 divided by 1,000,000 = 4 * $350 = $1,400.
Here’s a more typical example for tech startups: Hashbrown, Inc. has 20,000,000 shares of common stock authorized with a par value of $0.0001. It has gross assets of $1M and total issued shares of 9,000,000 to its founders.
- Assumed par value = $1,000,000 assets divided by 9,000,000 issued shares = $0.111111 assumed par.
- There are 20,000,000 shares of common stock authorized with a par value of $0.0001 which is less than the assumed par value of $0.111111. So, taking the higher assumed par value, $0.111111 multiplied by 20,000,000 authorized shares = $2,222,220
- There are no authorized shares with a par value greater than the assumed par value of $0.111111.
- Assumed par value capital = $2,222,220 plus $0.00 = $2,222,220 assumed par value capital.
- Round up to the next million = $3,000,000 assume par value capital.
- Tax bill = $3,000,000 divided by 1,000,000 = 3 * $350 = $1,050.
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