If you own a small business, then you’ve likely heard the terms “franchise tax,” “gross receipts tax,” and “privilege tax,” but you may not be clear on the difference between these and how these taxes can impact your business profits. In today’s post, I’ll explain how these state-level business taxes differ, and I’ll show how understanding them can strengthen your business’s overall financial strategy.
What’s the difference between franchise tax and gross receipts tax?
Both franchise tax and gross receipts tax are taxes imposed by state governments to collect from business owners. Collectively, these types of taxes are called privilege taxes because they are taxes owed to a state when the state grants the business the privilege of operating there.
A franchise tax is tax a business pays to the state for the right to exist or operate in that state. It’s not directly tied to sales but is usually calculated using factors like your business’s net worth, capital, or sometimes even a flat fee.
It’s important to note that the term “franchise tax” isn’t tied to owning a franchise in a company, which is probably most likely how you’ve heard this term before. Any type of business can owe franchise tax.
On the other hand, gross receipts tax is based on your business’s total revenue, which is the money your business brings in before any expenses are deducted.
You can think of the difference like this:
- Franchise tax = You owe a fee because you’re doing business here.
- Gross receipts tax = You owe money because you made money here.
How is franchise tax calculated for small businesses?
Franchise tax varies widely depending on the state, which is part of why it’s very confusing for small business owners. Some states charge a flat annual fee, while others base it on:
- Net worth
- Capital held in the state
- A percentage of income
One thing to keep in mind as a small business owner, especially one just starting out, is that states will expect you to pay franchise tax even if you didn’t turn a profit for the year and even if the amount of tax you owe is more than your profit.
How does gross receipts tax work?
Gross receipts tax is much more straightforward, but it can feel more painful. It’s calculated as a percentage of your total sales, without considering your expenses.
For example, if your business earned $500,000 in revenue, and your expenses were $450,000, that would leave you with a $50,000 profit. In a state with a 1% gross receipts tax, you would owe $5,000 in tax. That’s because the 1% is calculated off of your total revenue and not your profit.
Because of the way the gross receipts tax works, businesses with low margins can owe large tax bills, so it’s even more important for them to pay attention to their pricing and overall profit margins to make sure they remain financially sustainable.
Do all states have franchise or gross receipts taxes? Do some states have both franchise and gross receipts taxes?
No, not all states have franchise or gross receipts taxes. In fact, some states have neither and some states have both.
This is something to keep in mind if you operate your business across multiple states. Where you register your business and where you sell products can affect your total tax burden significantly.
Do you owe franchise or gross receipts tax just for shipping products to customers in another state?
The short answer is yes, sometimes states can impose a privilege tax on businesses that don’t have a physical presence in that state. Whether you owe these taxes depends on whether you have economic nexus in the state where you’re selling your products
For example, Ohio’s Commercial Activity Tax (CAT) must be paid if your sales in Ohio exceed $150,000, and they’ll expect payment even if you’ve never set foot in Ohio.
Quick reference — Ohio Commercial Activity Tax (CAT) thresholds
Ohio raised the CAT exclusion threshold significantly starting in 2024, and most small businesses no longer owe it. The $150,000 figure above applies to tax years 2023 and prior.
| Tax Year | Exclusion Threshold | Annual Minimum Tax |
|---|---|---|
| 2023 & Prior | $150,000 | $150 (minimum) |
| 2024 | $3,000,000 | $0 |
| 2025 & 2026 | $6,000,000 | $0 |
Source: Ohio Department of Taxation — Commercial Activity Tax. Threshold increases enacted under Ohio H.B. 33 (signed July 2023). Verified May 2026.
One thing to note is that not all states apply economic nexus to franchise taxes, but gross receipts taxes are more likely to apply based on sales alone.
Do you owe franchise or gross receipts tax in your home state if you don’t sell anything there?
Let’s say you live in Indiana and make handmade goods at home but you sell 100% of your inventory at conferences that take place out of state. If your state has franchise tax, then you’ll most likely still have to pay it because your business is registered in your home state or because you are legally domiciled there. It doesn’t matter where your customers are located.
As for gross receipts tax in this scenario, it would depend on how your state defines “sourcing” of revenue. If your state uses market-based sourcing, which is most common, then your revenue is taxed where the customer is located. However, your state could also use origin-based sourcing, which is less common. In that case, your revenue is taxed where the business operates.
Just remember that even if you made zero sales in your home state, you may still owe annual business fees and possible franchise-type taxes depending on your entity structure and your state’s rules.
Which states are most aggressive about taxing out-of-state sellers?
While rules do change often, a few states are infamous for their broad economic nexus rules:
- Ohio
- Washington
- Texas
- California
These states may require you to register and make tax payments based purely on sales volume into their state.
Why do states use gross receipts taxes instead of income taxes?
From a state’s perspective, gross receipts taxes are:
- Easier to administer
- Harder to avoid
- More predictable
From a small business owner’s perspective, they can feel unfair because they don’t take into account:
- High operating costs
- Thin profit margins
- Economic downturns
Which is worse for small business, franchise tax or gross receipts tax?
The answer to this depends on your business type and situation. Franchise tax is usually more predictable for business owners because it’s either a fixed rate or formula-based, and it’s typically smaller for small businesses. However, it is completely unavoidable, even if you’re not turning a profit yet.
Gross receipts tax can vary widely depending on how much your revenue varies. It can also be more costly for small business owners because it scales as your revenue scales, it ignores profitability, and it hits high volume but low margin businesses the hardest.
Can you deduct franchise tax or gross receipts tax?
The good news is that yes, both of these state privilege taxes are considered business expenses for federal income tax purposes. This means that they can reduce your taxable income at the federal level, and that will likely reduce your overall federal income tax bill.
How can small business owners plan for privilege taxes?
This is where proactive planning can make a big difference. Whether you’ll be paying franchise taxes or gross receipts taxes, or both, follow these steps to make sure you’re ready to pay any taxes owed:
- Educate yourself or work with a CPA to help you figure out your state’s requirements, thresholds, and calculation methods as well as nexus and revenue sourcing rules for any states where you sell your products.
- Monitor your revenue closely.
- Understand your profit margins.
- Build taxes into your annual budget and reassess your prices often to make sure you’re charging enough to pay the cost of any taxes you’ll owe.
Abridged by Amy
As a CPA, my advice about state-imposed privilege taxes is simple: Don’t wait until tax season to think about these. Understanding how business taxes work can help you price your services and goods correctly. This is an important step in managing your cash flow and avoiding any surprise tax bills.
If you’re unsure how these taxes apply to your specific business, then it’s worth getting individualized advice because sometimes even small differences in structure or location can lead to big differences in tax liability.
