The California Franchise Tax
New business owners in California are often unpleasantly surprised when they find out about the California Franchise Tax. At a minimum of $800, it’s one of the steepest franchise taxes in the country, and it’s imposed on nearly every business.
The California Franchise Tax is no joke. Fail to pay it and you’ll face steep fees and probably a suspension from the California Franchise Tax Board. However, in an effort to support small businesses through the Covid-19 crisis, California passed legislation that made any California LLC, LP, or LLP formed between January 1, 2021 and December 31, 2023 exempt from paying the California Franchise Tax for their first taxable year.
While this is good news for many of California’s small businesses, it’s important to remember that the exemption only applies for the business’s first taxable year. After that, California LLCs will need to begin paying the annual California Franchise Tax. Here’s our guide to understanding your California LLC tax obligations.
What is the California Franchise Tax rate?
What is the California Annual LLC Fee?
Who pays the California Franchise Tax?
Can I avoid back-to-back payments?
What if I change entity types?
When is the California Franchise Tax due?
Will I owe the minimum California Franchise Tax my first year in business?
My LLC or corporation is suspended. Do I still owe the California Franchise Tax?
Can I avoid the California Franchise Tax?
Can you help me form a business?
Your California Franchise Tax will be whichever sum is greater: $800 or the applicable tax rate percentage of your net income.
We know, it sounds confusing. Basically, you’ll have to pay at least $800. But if you have a high-earning corporation, you’ll probably have to pay more.
The California Franchise Tax rates depend on your business’s tax classification:
- C corporations: 8.84%
- S corporations: 1.5%
- Partnerships (such as LLCs, LPs, LLPs, LLLPs): $800
So if your business is taxed as a C corporation and makes $15,000 this year, you will owe $1,326 (8.84% of $15,000). If your corporation makes $5,000 this year, you will owe $800. That’s because your 8.84% of $5,000 is $442, and the minimum franchise tax is $800.
Liking the sound of a flat franchise tax rate for California LLCs? Don’t get too excited. High-earning LLCs don’t actually have much of a tax advantage over corporations because of something called the Annual LLC Fee.
The California Annual LLC Fee is imposed on any California LLC that brings in more than $250K annually. It starts at $900 and goes up from there:
|Net Income||Annual LLC Fee|
|$250,000 – $499,999||$900|
|$500,000 – $999,999||$2,500|
|$1,000,000 – $4,999,999||$6,000|
|$5,000,000 or more||$11,790|
Pretty much everyone. All businesses registered with the state of California have to pay the California Franchise Taxes (except for tax-exempt businesses like nonprofits).
This means that C corps, S corps, LLCs, LPs, LLPs, and LLLPs all are all responsible for the California Franchise Tax.
Sole proprietors and general partnerships don’t register with the Secretary of State and so are free from paying the California Franchise Tax.
If you’re considering forming a business towards the end of the calendar year, you might want to wait, if at all possible.
The California Franchise Tax is not prorated. Even if you form a business in November, you’ll owe a the minimum payment of $800 for that year, even if your LLC or corporation has only existed for a month. Then, when the new year rolls around, you’ll owe another $800. A $1,600 tax bill can be quite a burden on a new business.
To avoid back-to-back California Franchise Tax payments, you can hold off on forming your business until January or include a “future file date” on your articles of organization or incorporation when you file. Of course, this solution only helps if you’re able to put off forming a business until the new year.
You may decide that you’d like to convert your California corporation into an LLC or vice versa. It’s important to understand that if you do, you’ll owe a separate California Franchise Tax for both entities, even though it’s the same business.
That means if you convert your California corporation into an LLC, your corporation’s tax year will automatically end on the date of conversion. Your LLC’s tax year will begin the next day. This means that you’ll owe a minimum of $800 for the corporation and the flat fee of $800 for the LLC.
S corporations: the 15th day of the 3rd month after your tax year ends
C corporations: the 15th day of the 4th month after your tax year ends
LLCs: the 15th day of the 4th month from your formation date
In some cases, businesses don’t have to pay the minimum California Franchise Tax for their first year in existence. Before 2020, the only businesses eligible for the first-year franchise tax exemption were C corporations and S corporations. C corporations and S corporations still have to pay the California Franchise Tax rate. They’re just exempt from meeting the $800 minimum threshold. If a C corporation operates at a loss during its first year, it won’t owe any franchise tax payments. If a C corporation makes $5,000 in its first year, it will only owe $442 in franchise taxes for its first year (8.84% of $5,000) and doesn’t need to meet the $800 minimum.
This exemption is only available for the first year of a corporation’s existence. Every year after that, the corporation will have to pay a minimum of $800 in franchise taxes, even if it operates at a loss.
California LLCs, LPs, and LLPs that are formed between January 1, 2020 and December 31, 2023 are exempt from paying the California Franchise Tax for their first taxable year.
Yes. You’ll have to make your franchise tax payment for that year plus pay a $250 penalty to the California Franchise Tax Board. On top of that, you’ll continue to owe the California Franchise Tax until you reinstate your suspended business. You’ll need to revive your business first even if you simply want to dissolve your California corporation or dissolve your California LLC.
There’s no way for a registered business to legitimately avoid the California Franchise Tax.
Sole proprietors and general partnerships don’t have to pay the California Franchise Tax, but they also don’t have any personal liability protection. For some small businesses that have a low likelihood of being sued, operating as a sole proprietorship or general partnership may be good idea. However, most businesses will want to officially register with the California Secretary of State to limit personal liability.
Some web-based business owners are tempted to register an LLC or corporation in a different state in an attempt to sidestep the California Franchise Tax. As long as you’re doing business in California – defined by state as “engaging in any transaction for the purpose of financial gain within California” – this won’t work and could be considered tax evasion.
The California Franchise Tax is a hefty price to pay to do business, but most Californians wouldn’t want to live, work, and play anywhere else. We know, because we’re Californians!
We’d love to help you incorporate in California or form your California LLC. Our Sacramento, CA office is staffed with locals who know the ins and outs of forming and maintaining a business in California. Hire us and we’ll even throw in a California business address for you to use on your filings so you can keep your home address off the public record.