DELAWARE FRANCHISE TAX - Getting It Right
Nearly all Israeli startups that operate in the US will incorporate in Delaware. For that privilege, each Delaware corporation is required to file and pay an annual franchise tax by March 1, 2019. Unlike the standard income tax calculation, the franchise tax is due whether or not the US company actually has any profits. As a matter of fact, it is often times the companies which are generating significant losses which are required to pay the highest tax.
Understanding the Tax Calculation:
The franchise tax is calculated at $400 for each $1M (i.e. 0.04%) of company value based on authorized shares {הון רשום}. To simplify this concept, for a company which has raised $10M in financing and issued all its 10M authorized shares (and there are no other assets), the tax would amount to $4,000 (10 * $400).
However, things can get significantly more complicated when various factors come into play. To clarify, the company value is calculated by dividing the gross assets {נכסים לפי המאזן} (as reported on the company’s balance sheet) by the number of shares issued {הון מוקצה/מונפק} (per the cap table), thereby defining the value per share. Unfortunately, the company’s debt or other liabilities, no matter how significant, do not in any way offset the asset value. Such value per share is then multiplied by the total number of authorized shares {הון רשום} of the company to define the full company value for Delaware tax purposes. Effectively, the tax can be calculated by multiplying the full company value by 0.04%.
The good news though, is that for a company which only has 5,000 or less authorized shares, the above calculation is not required and only a minimum tax of $175 is due.
Tax Planning to Reduce the Franchise Tax:
The most common error we come across is where companies do not realize the impact of authorizing substantially more shares than are currently required for their cap table. To build on our prior example, the same company raised $10M of financing and issued 10M shares accordingly, thereby establishing a $1 value per share. However, the company actually has an additional 90M shares in outstanding stock, available for future financing rounds. However, those 90M shares have effectively added $36,000 (90 * 400) to their tax bill! To summarize, the legal and other related costs of increasing authorized shares at a later date will be substantially lower than this annual tax.
Another common error is when the US company is a subsidiary of the Israeli parent and overstates its authorized shares. In such case, authorizing and issuing only 5,000 shares is sufficient to establish 100% ownership by the Parent Company while only requiring an annual tax of $175. However, if the subsidiary does authorize 100M shares, it will automatically be catapulted into the complicated tax calculation outlined above which could have been so easily avoided.
Tax Tips:
Retain the minimum amount of shares required in your outstanding stock in order to avoid inflating company value for Delaware tax purposes.
If the US company is a subsidiary, issue only the minimum shares required i.e. up to 5,000.
Filing Process – Please send us the following information:
U.S. Subsidiaries (Entities with 5,000 shares or less):
Total Payment Due: $225
Provide list of current officers & directors
Mailing address
Payment Options: credit card or electronic bank transfer
U.S. Parent Companies:
The minimum amount due is $450. For most companies the tax due will amount to a few thousand dollars (see explanation of the tax calculation above).
If the final tax due is $5,000 or greater, then 2019 estimated tax payments will need to be calculated. They are due to be paid on June 1, 2019, September 1, 2019 and December 1, 2019.
Trial Balance for INC as of 12/31/2018
Trial Balance for LTD as of 12/31/2018
Cap table as of 12/31/2018
Provide list of current officers & directors.
Mailing address
Payment Options: credit card (if below $5,000) or electronic bank transfer
