Delaware, by its very nature, is considered as one of the most preferred locations for business incorporation in the US.
Among the distinct characteristics like business-friendly legal system , high level of business privacy and easy fundraising for business incorporators, Delaware tax system is one of the main reasons for the high rate of incorporation in the state.
Most Delaware taxes are usually imposed at federal and state levels. For the purpose of optimizing the use of the tax advantages, it is crucial for all business incorporators to get a comprehensive understanding of the Delaware taxation.
Let’s dive deep into how Delaware companies are taxed.
1. Corporate income tax (CIT)
Corporate income tax is subject to all domestic and foreign Delaware companies on profits sourced within the state.
Delaware companies which conduct business outside the state are not liable to the tax. This tax is based on an equally weighted three-factor method of apportionment. The factors are property, wages and sales in Delaware as a ratio of property, wages and sales everywhere.
The company income is taxed at state and federal level with different tax rates.
1.1 At the state level
Tax rates. Delaware companies have to pay 8.7% of their taxable income except for exempt cases under Section 1902(b), Title 30, Delaware Code.
Related forms. It is required for the companies to file form 1100, form 1100S or form 300 for the tax return.
Due date. The due date for tax filing is on or before April 15 of the following year in the case of calendar year companies.
Late payment or non-compliance penalty. A penalty will be imposed on Delaware companies for late filing. If the companies fail to pay properly the tax liability, it will be charged at 1.5% of the unpaid tax amount for each month from the first month of late payment. For late tax returns, the fine will be 5% of the tax liability, plus 1% interest of the tax amount for each month. The maximum penalty is 50% of the CIT.
1.2 At the federal level
Tax rate. 21% of taxable income will be the tax amount obligated for Delaware companies at this level.
Related forms. Delaware companies are required to file form 1120 or form 1120S for the tax return.
Due dates. The due date for tax filing is set the same with the state level for a calendar year taxpayer. For a fiscal year taxpayer, the tax must be paid by the 15th day of the 4th month after the end of its tax year.
Late payment penalty. The penalty for late tax filing is 5% of unpaid tax for each month from the first month of late payment. The maximum amount is 25% of the CIT.
For both state and federal levels, the estimated tax payment will be prepaid in four installments as follows:
- 50% (due on or before 1st day of 4th month of the taxable year)
- 20% (due on or before 15th day of 6th month of the taxable year)
- 20% (due on or before 15th day of 9th month of the taxable year)
- 10% (due on or before 15th day of 12th month of the taxable year)
2. Personal income tax
Personal income tax is the tax amount applied to individuals with income or loss sourced in Delaware. The tax policies will be designed differently for residents and non-residents.
For many Delaware companies such as Limited Liability Companies, Sole proprietors, the company income and loss is reported as the personal income for tax returns.
In the same manner with CIT, the Delaware tax system requires personal income tax to be levied at state and federal levels with separate methods and filing forms.
2.1 At the state level
- For Delaware residents, the tax rate will fluctuate from 2.2% to 5.55% for income smaller than $60,000. The maximum rate will be 6.6% for income equal or greater than $60,000.
- Delaware non-residents are required to pay personal income tax at the rate of 6.6%.
Related forms. Residents use form 200-01 for the tax return filing, meanwhile, non-residents use form 200-02 NR.
The estimated tax payments are set in the same four installments like CIT.
2.2 At the federal level
- For US residents, Delaware uses 7 brackets with tax rates of 10%, 12%, 22%, 24%, 32%, 35% and 37% to determine tax payments for individuals. It is required to file form 1040 for tax return filing and form 1040-ES for estimated tax payment with due generally on April 15th.
- For non-US residents, there are two categories used to determine Delaware personal income tax:
- Effectively Connected Income (ECI) with a trade or business in the United States with same rates applied to U.S. citizens
- Fixed, Determinable, Annual, or Periodical (FDAP) U.S. source income with flat rate of 30 % (or lower treaty rate, if qualify)
Related forms. Form 1040-NR is used for non-resident tax filing with the same due as the residents. The estimated tax payment uses form 1040-ES for the process.
2.3 Non-compliance penalty
The penalty for failing to pay personal income tax for both levels are as below:
- Late filing:
- Usually 5% of the amount due for each month or part of a month when the return is late without a reasonable explanation.
- 15% per month, up to a maximum of 75%, if the failure to file is fraudulent.
- If the return is more than 60 days late, the minimum penalty amount will be $435 for the amount of any tax owed, whichever is smaller.
- Late payment of tax:
- Usually 1/2 of 1% of the unpaid amount for each month or part of a month the tax isn’t paid
- This penalty is in addition to interest charges on late payments
- Frivolous return:
- $5,000 for filing a frivolous return (not contain information needed to figure the correct tax or shows a substantially incorrect tax)
- Criminal penalties may be imposed for willful failure to file, tax evasion, making a false statement, or identity theft.
3. Franchise tax
Franchise tax is obligated for every domestic and foreign Delaware company except for the exemption corporations defined under Delaware law. Delaware companies must pay the tax to maintain the privileges and good standing status for legal existence in the state.
The amount of franchise tax payment is not associated with the corporate income, but it depends on the business entity type of the companies.
For limited liability companies, partnerships, sole proprietorship companies, an annual fee of $300 is the obligated payment for the franchise tax.
For corporations, the tax amount is based on two calculations, which are Authorized Shares Method and Assumed Par Value Capital Method. The Par Value is the initial selling price of shares.
The minimum taxable amount is $175 for the calculation using authorized shares and $400 for the assumed Par Value capital method. The maximum tax payment using both methods is $200,000.
The due date for the tax payment is on or before 1st of March. A penalty system will be subject to the companies with late or improper payment.
Discover Delaware Franchise Tax And Annual Report to better understand how these calculations and the payment procedures are processed under the state’s regulations.
4. Other Delaware tax types
4.1 Withholding tax (Employment tax)
For any Delaware companies which hire employees for business operations, it is required to annually do withholding tax filing for the employees.
A certain amount will be withheld from the employees’ wages or salaries originated from their activities within the state.
Foreign Delaware companies are required to do the tax filings if they conduct their business within the state border.
The withholding tax payment will be processed upon quarterly, monthly, or eight-monthly basis depending on the withheld amount and with the corresponding filing forms and dues as below:
- Quarterly basis: file form W-1Q with due on the last day of the month following the end of a quarter.
- Monthly basis: file form W-1 with due on the 15th day of the month following the end of a month.
- Eighth-monthly basis: file form W-1A with due on the 3rd day after the end of each payment period (exclusive weekends and holidays).
To ensure the proper tax compliance for the company, it is compulsory to obtain W-4 Forms from the employees with their signature in the forms.
Then, the employers must issue and file form W-2 and 1099 forms (1099-MISC, 1099-NEC, or 1099-R) to the Division of Revenue to complete the Delaware withholding tax settlement.
4.2 Tax associated with Effectively Connected Income (ECI)
If a foreign company engages the business in Delaware, all incomes or losses which are sourced within the border are treated as the Effectively Connected Income. A foreign Delaware company will be subject to the tax obligations for the ECI. Below are the main ECI categories:
- Investment income
- Personal Service Income
- Transportation Income
- Business Profits and Losses and Sales Transactions
- Real Property Gain or Loss
- Gain or Loss from Sale or Exchange of Certain Partnership Interests
The investment income such as interest, dividends, and royalties will be determined whether it is ECI under asset used test and business-activities test.
The investment income may or may not be categorized as ECI under three items as follows:
- Fixed or determinable income (interest, dividends, rents, royalties, premiums, annuities, etc.).
- Gains (some of which are considered capital gains) from the sale or exchange of certain types of property.
- Capital gains (and losses).
4.3 The tax for Fixed, Determinable, Annual, or Periodical (FDAP) income (30%)
As defined by IRS, FDAP is all incomes rather than:
- Gains derived from the sale of real or personal property (including market discount and option premiums, but not including original issue discount)
- Items of income excluded from gross income, without regard to the U.S. or foreign status of the owner of the income, such as tax-exempt municipal bond interest and qualified scholarship income
Income is fixed when it is paid in amounts scheduled in advance.
Income is determinable whenever there is a basis for calculating the taxable amount. Income can be periodic if it is paid occasionally, and there is no need to be paid annually or at regular intervals. Whichever the time length for applicable payments is increased or decreased, income can be determinable or periodic.
30% tax rate or the lower treaty rate will be levied on FDAP income or gains sourced in Delaware, except for the effectively connected income. The rate is imposed on the gross amount of Delaware source fixed or determinable annual or periodic gains, profits, or income.
4.4 Self-employment tax (SE tax)
All business owners who take profits from the Delaware businesses are subject to self-employment tax.
The tax is also known as the Federal Insurance Contributions Act tax (FICA) and Social Security or Medicare tax. It is required for business operators to pay SE tax in the cases listed as below:
- Trade & business as a sole property or independent contractor
- Members of partnership trade & business
- Otherwise do business for yourself (including part-time)
As Delaware residents, the tax rate will be:
- 15.3% (12.4% social security tax plus 2.9% Medicare tax), and
- 0.9% Additional Medicare Tax based on Net income.
Delaware doesn’t impose SE tax on non-residents unless the International Social Securities Agreement determines so.
The tax can be filed using form 1040 or 1040NR and paid in quarterly estimated tax payment.
4.5 Excise tax
Delaware companies will be taxed for the sale of specific goods, services, and activities within the border. The taxpayers can be manufacturers, retailers, or consumers.
Below are the main categories which Delaware legislate the application of excise tax:
- Excise Tax on Coal
- Fuel Tax Credits
- Oil Spill Liability Tax
- Sports Wagering
- Excise Tax on Indoor Tanning Services
- Exemption for Amounts Paid for Aircraft Management Services
- Excise Summary Terminal Activity Reporting System (ExSTARS)
Delaware is considered as the ideal domicile destination for the business incorporation within the state for its favorable tax system. However, it is important to know how to facilitate the tax advantages for smooth and efficient business activities.
When it comes to business setup or operation, taxation is always a thorny issue to most business operators. It is advised for the incorporators to consult the professionals for matters relating to the Delaware tax system.
Still uncertain about tax filing issues for your Delaware company?
BBCIncorp x TaxHub partnership offers an efficient tax solution for non-resident companies incorporated in Delaware. As BBCIncorp’s clients, TaxHub provides certain privileges for your company. Contact us now!