California has a reputation as a tax hungry state. As you will soon see, that reputation is well earned. What follows is a quick introduction to the rules regarding California Franchise Tax Fees.
The Franchise Tax Fee is a fee that California imposes on businesses that are operating as C-Corporations, S-Corporations, or LLCs. This fee will cost a minimum of $800 per year, however, in some cases (particularly with LLCs), you can end up paying considerably more.
What is the California Franchise Tax?
The California Franchise Tax is a fee imposed by California on certain entities for the privilege of doing business in California. This fee is a minimum of $800 per year, and it imposed on LLCs, S-Corporations, and C-Corporations. Partnerships and sole proprietorships that are not setup as LLCs are exempt from this tax.
What do you mean a minimum of $800 per year?
While the $800 fee is the absolute minimum tax that you will pay every year, in certain situations you will pay more. There are different rules for LLCs, S-Corporations, and C-Corporations. Here’s how it works:
- Minimum California Franchise tax of $800 per year. However, this fee is waived for the first year a newly formed corporation files its initial tax return.
- A flat tax of 8.84% also applies. This is never waived, so a corporation will be subject to it in its first year. However, the tax that you must pay in California is the greater of the $800 minimum fee or 8.84% of the corporation’s net taxable income. Therefore, the 8.84% doesn’t begin to kick in until the corporation has surpassed $9,050 in taxable income ($9,050 * .0884 = $800 in tax, which is already paid via the minimum franchise fee).
- Minimum California Franchise tax of $800 per year. Similar to a C-Corporation, this fee is waived for the first year a newly formed corporation files its initial tax return.
- Even though an S Corporation is a pass-through entity for Federal purposes, California assesses a 1.5% tax on an S Corporation’s net taxable income. This tax is the greater of $800 or 1.5% of the S-Corporation’s net taxable income. So, as a practical matter, this won’t start to kick in until around $53,350 in income ($53,350 * .015 = $800).
Limited Liability Companies:
Limited Liability Companies can be taxed as sole proprietorships, partnerships, or corporations (although they generally operate and are taxed as partnerships). The Franchise Tax Fee for LLCs isn’t that much worse than it is for corporations, however, they are also subject to an LLC fee that can get quite expensive.
LLC Franchise Tax:
- Minimum California Franchise tax of $800 per year. Unlike corporations, this fee is not waived in the first year.
LLC’s are also subject to California’s LLC Fee. This fee is as follows:
- $900 for revenue between $250,000 and $499,999,
- $2,500 for revenue between $500,000 and $999,999,
- $6,000 for revenue between $1,000,000 and $4,999,999, and
- $11,790 for revenue of $5,000,000 or more
As noted above, this fee is assessed based on revenue, not taxable income. So if you have an LLC that makes over $250,000 in revenue and nets ~$50,000 after expenses (not uncommon in certain industries), then you will have to pay $1,700 in Franchise Tax and LLC fees to California every year.
Can I Get Out Of the Franchise Fee By Registering in Nevada?
This is a popular myth, but unfortunately, no, it doesn’t work that way.
The California Franchise Tax Fee is based upon the privilege of doing business in California, not upon where your state or LLC was formed. If you have nexus in California, you are subject to California taxation, and that includes the Franchise Tax.
It is very common for Californians – both residents, and entities that they have formed – to try to avoid California taxes by pretending to live in other states. Unfortunately for would be tax avoiders, the FTB is all over this one, and they are one of the most aggressive tax agencies in the country. If you get caught trying to avoid California taxes, you will get hammered. Your best bet is to play by the rules.
There are a variety of reasons why forming an LLC or a corporation might be a good idea for your business. In particular, LLCs and corporations offer asset protection benefits that a sole proprietorship or general partnership does not.
However, if you choose to incorporate or form an LLC in California, you will be subject to the California Franchise Tax, and possibly the LLC Fee as well. Therefore, you should consult with a knowledgeable tax advisor before forming a corporation or LLC.