California LLC Gross Receipts Tax
The California LLC gross receipts tax was instituted in the state in 2010 and the fee is based on the total income of the LLC.5 min read
2. California Gross Receipts Tax
3. California Annual Franchise Tax
4. Exceptions to the Annual California Franchise Tax
5. Self-Employment Tax
Updated October 22, 2020:
The California LLC gross receipts tax was instituted in the state in 2010. The fee is based on the total income of an LLC. Along with the annual franchise tax fee of $800 that is imposed on all LLCs and corporations operating in the state, the additional gross receipts tax applies to LLCs. However, corporations are not required to pay the gross receipts tax.
About Business Types
When starting a business, one of the areas an individual must consider is how the business must be organized to satisfy the state laws where it will be located. Two common options for organizing a business is as a limited liability company (LLC) or as a corporation (designated as a C corporation). There are pros and cons to each business type.
When a business is set up as a C corporation, it is subject to double taxation. There is one tax on the corporation's profits, and a second tax is levied on dividends paid to shareholders, which is counted as income.
Another option is the S corporation. In terms of taxation, an S corporation is like a limited liability company; the business is considered a pass-through entity. This means any profits earned by the company are passed as income to the owners, which equates to a single tax. When a company is looking for the option of pass-through taxation, an LLC or S corporation are the usual choices.
An LLC registered in California will be treated in one of two ways: either as a sole proprietorship (disregarded entity) when there is a single member or as a partnership if the business has more than two members.
Typically, unless an LLC is formed for real estate purposes, business owners choose to form a corporation. This is a better option for owners due to the expense of operating a business in California and the tax disadvantages imposed on California LLCs.
California Gross Receipts Tax
The state of California already has a challenging economic climate, and this new tax now requires additional payment on gross revenue. The average business must generate $250,000 or more in gross receipts in order to break even, and the addition of this tax means that LLCs operating in California end up paying higher franchise taxes than corporations. Even if an LLC is operating at a loss, it still has to pay the tax if its gross revenue is $250,000 or more.
On the other side, corporations in California are not subject to the gross receipts tax. The result of this added tax is LLCs moving to other states so they don't have to pay the additional amount. This tax, also known as the LLC fee, is required in exchange for the privilege of operating in California. This additional tax burden only applies to LLCs in the state.
The gross receipts tax amount is based on the revenue of the LLC:
- $0 to $249,999 Gross Revenue = no gross receipts tax required
- $250,000 to $499,999 gross revenue = $900
- $500,000 to $999,999 gross revenue = $2,500
- $1,000,000 to $4,999,999 gross revenue = $6,000
- $5,000,000+ gross revenue = $11,790
S corporations in California have a different taxation system. These corporations are taxed at 1.5 percent of the net income. An LLC is taxed on the gross receipts based on the scale outlined above. As a result, the amount of profit and gross receipts generated by a company bring different benefits when operating as an LLC versus an S corporation.
LLCs formed in California as well as those formed outside of California but operating within the state are required to pay both types of taxes in exchange for the privilege to operate there. When any LLC takes in at least $250,000 in total gross income in a single year, the business is required to pay the additional LLC gross receipts fee. The total income used to calculate the gross receipt fee doesn't include any gain allocation or distributions from other LLCs in which a member is shared between the two companies.
For income tax purposes in California, LLC members may deduct the gross receipts fee. All LLCs must pay the required gross receipts fee on or before the 15th of the sixth month of the year. Since the due date is early in the year, an LLC must plan ahead and make a reasonable estimate of its expected gross revenue for the year. The tax must be paid based on the estimate.
If an LLC does not pay enough, a penalty for underpayment of 10 percent will be added. The only exception to this penalty is if the fee estimated is equal to or greater than the amount paid in the previous year. LLCs are often used in the real estate market within the state. However, operating a business that is formed as an LLC requires payment of at least $800 in franchise tax, along with the second gross receipts tax.
Since the average company has to make $250,000 or more in gross receipts to break even, operating an LLC can be challenging in California. LLCs end up paying higher franchise taxes than corporations, even when operating at a loss.
California Annual Franchise Tax
Nearly every LLC formed in California and every foreign LLC (those that are formed out of the state) has to pay a minimum of $800 every year in the minimum annual franchise tax. This must be paid every fiscal year, even if no business was conducted during the year or if the business is operating at a loss. California does not prorate the fee for partial years, which means that even a business formed in the middle or toward the end of a year would have to pay the full $800 fee.
Exceptions to the Annual California Franchise Tax
There are several exceptions that apply for short periods during a calendar year when there has been no business activity. These include:
- A nonprofit organization set up with a tax exemption.
- Certain types of LLCs that are owned by deployed members of the U.S. Armed Services.
- An LLC that has elected S corporation taxation.
Additional information to note:
- The franchise tax for a California Corporation is based on its net revenues.
- For an LLC, the gross revenue is used to determine the franchise tax.
- When filing a California LLC tax return, the $800 franchise fee is not deductible.
- The franchise fee of $800 is due for the taxable year and must be paid by day 15 of the fourth month.
There are differences between an LLC, C corporation, and an S corporation when it comes to self-employment tax. For LLCs, net income is considered self-employment income and duly taxed at the rate of 15.3 percent for FICA. This tax is in addition to state and federal income taxes.
Shareholders of a corporation registered in California do not pay self-employment tax. Instead, shareholders are subject to a 15 percent tax on capital gains on distributed profits.
An S corporation typically provides a reasonable salary to its shareholders/employees. Taxes are paid on the salary. The tax rate is 7.65 percent for declared salaries for the S corporations' employees and officers. Any remaining balance of those profits is paid via a dividend. The dividends are not subject to payroll or income taxes but are subject to the 15 percent rate on capital gains.
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