Key Takeaways

  • California LLCs are subject to various taxes, including an $800 annual franchise tax, an income-based LLC fee, and federal self-employment taxes.
  • Businesses need to consider additional costs, such as sales tax, non-consenting non-resident member taxes, and potential penalties for late payments.
  • LLC tax rates in California are determined by income brackets, with higher income generating higher fees.
  • Strategies to reduce tax liability include leveraging tax deductions, understanding state exemptions, and proper financial planning.
  • UpCounsel offers resources for connecting with attorneys to navigate the complexities of California LLC taxes.

California LLC tax rates are $800 for LLC tax, an LLC fee that ranges from $0 to $11,790, and FICA tax at 15.3% of taxable wages. The rates for sales tax and Nonconsenting Nonresident members' tax vary depending on the location of the LLC and the people involved.

California State Taxes and the LLC

California has three types of taxes on business: corporate tax, franchise tax or an alternative minimum tax, and income tax. Most businesses are subject to two or three of these taxes. A California LLC is by default treated as a disregarded entity if it has one member or a partnership if it has more than one member. LLCs are not subject to corporate tax because they have pass-through status but are subject to a number of California state taxes on the personal income of the owners. 

This double taxation, relatively high tax rate, and the possibility of taxing LLC owners on some profits the owners that are directly reinvested in the business stack the odds against small businesses in California.

Understanding Additional California LLC Tax Obligations

  • Sales Tax: LLCs conducting retail operations must collect and remit California sales tax, with rates varying by location.
  • Non-Consenting Non-Resident Member Tax: For LLCs with non-resident members, California imposes a withholding tax on their share of income, typically at the rate of 7%.
  • Local Taxes: Depending on the business's location, additional local taxes and permits may apply.

Franchise Tax

California Franchise tax is charged on most businesses in the state including corporations, LLCs, and partnerships. The California Franchise Tax Board explains that the tax is charged for the "privilege of conducting business in California." Each LLC is charged a minimum LLC tax of $800. This amount is levied on most domestic and foreign LLCs registered in California, whether they did business in that tax year or not. Even inactive businesses keep accumulating the tax as long as they are still registered with the California secretary of state. 

In addition to the static LLC tax, there is a variable LLC fee which increases as the total income of the LLC goes up. Unlike the calculations for the tax rates of corporations, both the LLC fee and LLC tax are not dependent on profits. 

The state of California defines total income as the total revenues the company gets from California. Before 2007, the California Franchise Tax Board claimed that it could tax a California LLC's income from anywhere in the world, but courts adjusted the law.

The total income tiers and their tax rates are as follows: 

  • An LLC whose income is below $250,000 is not charged an LLC fee, therefore, the total franchise tax is $800.
  • LLCs whose total income is between $250,000 and $499,999 are charged an LLC fee of $900, bringing the total tax to $1700.
  • LLCs with incomes from $500,000 to $999,999 pay an LLC fee of $2,500, making the total franchise tax $3,300.
  • LLCs whose total income is between $1,000,000 and $4,999,999 are charged an LLC fee of $6,000 making the total franchise tax $6,800.
  • If the LLC's total income is $5,000,000 and above, the fee is $11,790 bringing the total tax to $12,590.

To pay franchise tax in California, LLCs file the Limited Liability Company Return of Income form, Form 568. The $800 is paid for all years the LLC is in operation including the first and last years even if the LLC is in operation for just part of the year.

The exception to this is some LLCs that apply for short periods and don't do business, nonprofits with tax-exempt status, some LLCs owned by members of the US Army, and certain LLCs that choose to be treated as S corporations. Some LLCs that are not subject to the franchise tax are instead required to file the Partnership Return of Income form, Form 565.

Penalties and Compliance for Franchise Tax

  • Late Payment Penalties: Failing to pay the $800 annual franchise tax can result in a 5% penalty of the unpaid tax, plus an additional 0.5% monthly penalty until settled.
  • Suspension Risks: Non-payment or failure to file required forms can lead to suspension or forfeiture of LLC rights in California.
  • Avoidance Strategies:
    • Apply for deferrals in cases of economic hardship.
    • Monitor deadlines to ensure timely filings.

Avoiding the LLC tax

The $800 LLC tax for small businesses in California can only be legally avoided if the company registers as a sole proprietorship. However, this is a decision you should only make if you are willing to operate without liability protection for your personal assets.

Some companies attempt to sidestep the tax by incorporating in other states. But, if the FTB finds out from your tax returns that you conducted business in California, you will be required to pay the tax anyway.

Maximizing Tax Deductions for California LLCs

  1. Home Office Deduction: Deduct a portion of rent or mortgage interest if part of your home is exclusively used for business.
  2. Business Expenses: Write off expenses such as equipment, utilities, and professional services.
  3. Startup Costs: Deduct up to $5,000 in business startup expenses in the first year.
  4. Retirement Contributions: Contributions to retirement accounts like SEP IRAs can reduce taxable income.

Federal Taxes

The net income that is generated by an LLC is considered self-employment income and is subject to a 15.3% tax in addition to the state taxes on the LLC. 

Navigating Federal Tax Obligations for LLCs

  • Self-Employment Tax: Covers Social Security and Medicare taxes at a combined rate of 15.3%.
  • Tax Forms:
    • Schedule C: For single-member LLCs treated as sole proprietorships.
    • Form 1065 and Schedule K-1: For multi-member LLCs treated as partnerships.
    • Schedule SE: To calculate self-employment tax.
  • Election for Tax Treatment:
    • LLCs can elect to be taxed as S Corporations, potentially saving on self-employment taxes by splitting income into wages and distributions.

FAQ Section

  • What is the minimum tax for an LLC in California?
    • Every LLC must pay an $800 annual franchise tax, regardless of income or activity level.
  • How are LLC tax rates determined in California?
    • Rates depend on total income, with additional fees for income above $250,000 and tiered brackets up to $11,790.
  • Can California LLCs avoid the franchise tax?
    • Only LLCs classified as sole proprietorships or those granted specific exemptions can avoid the tax.
  • What forms do I need to file taxes for my LLC in California?
    • Form 568 for California franchise taxes and the appropriate federal forms based on the LLC's tax classification.
  • How can I reduce my LLC's tax liability?
    • Take advantage of business expense deductions, explore S Corporation election, and ensure compliance with tax regulations.

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