Most startup founders choose Delaware for its business-friendly laws, specialized Court of Chancery, and investor preference. But one critical decision at incorporation – the number of authorized shares and their par value – can significantly impact your annual Delaware Franchise Tax liability.
In this article, we have dealt with the concept of Delaware Franchise Tax, the methods used to compute the same, and illustrative examples of what authorized shares and par value need to be chosen in different scenarios.
Background
Most startup founders set up their entity in Delaware due to its business-friendly laws, specialized Court of Chancery, and investor preference.
For any founder or promoter forming a Delaware Corporation, one significant aspect to consider is the number of authorized shares the entity maintains, and the corresponding par value of those shares.
The par value of stock chosen by the company affects several structural aspects of the entity, including equity, capital, and ownership.
The capital requirement varies from corporation to corporation based on their respective needs. Typically, the capital requirement is as follows:
- A startup founder who wishes to raise funds from investors in the United States would have to raise considerable value of capital in the company.
- A service company set up in the US only for marketing and invoicing purposes might not require much capital in the company.
- A trading entity which acquires high value of goods might require lower capital but would have a high value of gross assets.
The above requirement of capital or gross assets will determine the amount of Delaware Franchise Tax your company must pay. Therefore, there should be an upfront understanding at the time of incorporation since the authorized shares and par value are the key determinants for computing the Delaware Franchise Tax.
Delaware Franchise Tax: Concept and Applicability
Every corporation incorporated in Delaware must pay an annual Delaware Franchise Tax. It is a separate and distinct tax from Delaware’s corporate income tax – it is a fee for the privilege of being incorporated in Delaware, regardless of whether they conduct business within the state or generate any revenue.
All Domestic and Foreign LLCs, Limited Partnerships, and General Partnerships formed or registered in Delaware are required to pay a flat annual tax of $300, regardless of the capital or asset base.
For Domestic corporations, there are two methods prescribed by the Delaware Division of Corporations to calculate the annual franchise tax. Corporations may use whichever method results in a lower Delaware Franchise Tax liability.
Authorized Shares Method
This method is purely based on the number of shares authorized. The par value or the gross assets of the entity do not impact the annual Delaware Franchise Tax. The minimum amount of tax under this method is USD 175 and the maximum is USD 200,000.
| Authorized Shares | Tax |
| 1 – 5,000 | $175 |
| 5,001 – 10,000 | $250 |
| Each additional 10,000 (or fraction thereof) | +$85 |
| Maximum | $200,000 ($250,000 for large corporate filers) |
Assumed Par Value Capital Method
This method ignores the actual par value of the shares issued and uses the following formula:
- Assumed Par Value of Shares = Total Assets ÷ Issued Number of Shares
- Assumed Par Capital = Assumed Par Value of Shares × Number of Authorized Shares
Depending on the assumed par capital, the Delaware Franchise Tax rates have been prescribed. The minimum amount of tax under this method is $400. For every increase of $1 million (or part thereof) in assumed par capital, there shall be an additional franchise tax of $400.
Illustrative Scenarios for Delaware Franchise Tax Computation
Note: The tax calculations in these illustrations are estimations only. The exact Delaware Franchise Tax amount will depend on the entity’s specific details and facts. Corporations will also be charged a $50 annual report fee. Additional fees may apply when filing.
Startup Entity with Potential Fund-Raising in the US
| Particulars | Response |
| Nature of the Company | Holding Company |
| Authorized shares at incorporation | 10 million |
| Issued shares (Pre fund raise) | 9 million |
| Issued shares (Post fund raise) | 9.5 million |
| Par value per share | $0.00001 |
| Investment value | $4.5 million |
| Expected gross assets (post fund raise) | $5 million |
| Franchise tax under Authorized Shares Method | $85,165 |
| Franchise tax under Assumed Par Capital Method | $2,400 |
| Final Delaware Franchise Tax liability (lower of above) | $2,400 |
Our Remarks: If there is a potential fund-raising requirement, it is preferable to keep a higher number of shares (e.g., 10 million) with a low par value (e.g., $0.00001). Subsequent issuance of shares due to new fund raises can further reduce the assumed par value per share, thereby lowering the Delaware Franchise Tax burden under the Assumed Par Value Capital Method.
Billing, Marketing, or Back-Office Entity with Foreign Promoters (No Fund Raise / ESOP Plan)
| Particulars | Response |
| Nature of the Company | Subsidiary Company |
| Authorized shares at incorporation | 5,000 |
| Issued shares | 4,000 |
| Par value per share | Any par value |
| Expected gross assets | No limit |
| Franchise tax under Authorized Shares Method | $175 |
| Franchise tax under Assumed Par Capital Method | N/A |
| Final Delaware Franchise Tax liability (lower of above) | $175 |
Our Remarks: If the entity is a mere marketing and invoicing entity in the US with no requirement for capital, the authorized shares can be kept at a nominal number (e.g., 5,000). This ensures that the Delaware Franchise Tax is computed only under the Authorized Shares Method, as the Assumed Par Capital Method is applied only when the number of shares is higher.
Entity with High Value of Inventory / Assets in the US
| Particulars | Response |
| Nature of the Company | Subsidiary Company |
| Authorized shares at incorporation | 20,000 |
| Issued shares | 15,000 |
| Par value per share | $1,000 |
| Expected gross assets | $50,000,000 |
| Franchise tax under Authorized Shares Method | $335 |
| Franchise tax under Assumed Par Capital Method | $26,800 |
| Final Delaware Franchise Tax liability (lower of above) | $335 |
Our Remarks: If there are high-value assets deployed in the US with no requirement to fund raise or issue ESOPs, it is beneficial to have a higher par value and a lower number of authorized shares. An increased authorized share count with a low par value in this scenario will lead to a significantly higher Delaware Franchise Tax liability.
Holding Company with US Shareholders and ESOP Issuance
| Particulars | Response |
| Nature of the Company | Holding Company |
| Authorized shares at incorporation | 10 million |
| Issued shares (including ESOP) | 9.5 million |
| Par value per share | $0.00001 |
| Expected gross assets (post fund raise) | $1 million |
| Franchise tax under Authorized Shares Method | $8,665 |
| Franchise tax under Assumed Par Capital Method | $400 |
| Final Delaware Franchise Tax liability (lower of above) | $400 |
Our Remarks: Employees are generally attracted by the number of shares they receive in the ESOP. At the same time, a higher number of shares might result in a higher Delaware Franchise Tax under the Authorized Shares Method. Having a lower par value (e.g., $0.00001) ensures that the franchise tax payable remains beneficial under the Assumed Par Value Capital Method, satisfying both requirements.
Conclusion
The Delaware Franchise Tax, while seemingly straightforward, can result in significantly different outcomes depending on the structural choices made at incorporation – particularly the number of authorized shares and the par value assigned to them.
As illustrated across the various scenarios, a one-size-fits-all approach is not advisable. A startup eyeing future fundraising rounds benefits from a high share count with a minimal par value, while an asset-heavy trading entity or a simple billing subsidiary is better served with fewer authorized shares or a higher par value.
The choice of the right method – Authorized Shares or Assumed Par Value Capital – can result in significant Delaware Franchise Tax savings.
It is also advisable to evaluate whether Delaware is the preferred state to set up in, considering the specific requirements of the company.
We strongly recommend consulting with a qualified advisor before finalizing your share structure, as early decisions can have a long-lasting impact on your annual Delaware compliance costs.
Frequently Asked Questions
What is Delaware Franchise Tax and who needs to pay it?
Delaware Franchise Tax is an annual fee paid to the state of Delaware for the privilege of being incorporated there. Every domestic Delaware corporation must pay it, regardless of whether the company does any business in Delaware or generates revenue. It is separate from Delaware corporate income tax. LLCs and partnerships pay a flat $300 annually.
What are the two methods to calculate Delaware Franchise Tax?
The Delaware Division of Corporations prescribes two methods: the Authorized Shares Method, which is based purely on the number of authorized shares (minimum $175, maximum $200,000), and the Assumed Par Value Capital Method, which factors in total assets and issued shares (minimum $400, with $400 added per $1 million of assumed par capital). Corporations may use whichever method results in a lower tax.
How does the number of authorized shares affect Delaware Franchise Tax?
Under the Authorized Shares Method, a higher number of authorized shares directly increases your Delaware Franchise Tax. Under the Assumed Par Value Capital Method, a higher share count with a low par value can actually reduce tax by lowering the assumed par value per share. The optimal structure depends on your company type, capital needs, and whether you plan to raise funds or issue ESOPs.
What par value should a startup choose for Delaware incorporation?
Startups planning to raise venture capital or issue ESOPs typically benefit from a very low par value (such as $0.00001) with a high authorized share count. This minimizes Delaware Franchise Tax under the Assumed Par Value Capital Method. Service or billing entities with no fund-raising needs are better off with a minimal share count (e.g., 5,000 shares) to keep tax at the $175 minimum.
When is Delaware Franchise Tax due?
Delaware Franchise Tax for corporations is due annually on March 1st. Corporations must also file an annual report along with the tax payment. The filing fee is $50 in addition to the franchise tax. LLCs and partnerships pay their flat $300 tax by June 1st each year.
Can the Delaware Franchise Tax be reduced after incorporation?
Yes. If you initially filed using the Authorized Shares Method and paid a higher amount, you can recalculate using the Assumed Par Value Capital Method and claim a refund for the difference. Going forward, your tax advisor can also help structure share issuances to keep the assumed par value low, reducing annual franchise tax liability.
Does a Delaware company always need to pay franchise tax even if it has no revenue?
Yes. Delaware Franchise Tax is not based on revenue or profitability. It is a tax on the privilege of incorporation. Even if your Delaware corporation has zero revenue, zero employees, or conducts no business, the annual franchise tax obligation remains. This is why understanding the tax implications at incorporation is critical.
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M2K Advisors is an international tax advisory firm having offices in India, Singapore, USA & UAE. Our firm offers varied services in USA such as setting up companies in Delaware and other states in USA, tax advisory, tax return filing, state & local tax compliance, sales & use tax compliance, IRS audit representation, FBAR & FATCA filing. M2K Advisors is the specialist firm for businesses managing US tax obligations. Our focused expertise in M&A and cross border structuring, state & local nexus studies, and multi-state compliance makes us the most reliable partner for foreign entities and startups entering the USA market.
Get in touch with us: mukesh@m2kadvisors.com, knowledge@m2k.co.in, info@m2kadvisors.com
