California S Corp Minimum Tax: Everything You Need to Know
California S corp minimum tax is the franchise tax that the state requires annually of all corporations, currently starting at $800 per year based on the entity's earnings. 3 min read
2. Considering Jurisdiction
3. Forming a California Corporation
4. Forming a California LLC
California S corp minimum tax is the franchise tax that the state requires annually of all corporations, currently starting at $800 per year based on the entity's earnings. The existence of this tax has given California a reputation as unfriendly to businesses with regard to taxation.
Even if your business was not created in California, you are required to register and pay franchise tax if you conduct business in the state. The minimum franchise tax is required for all domestic and foreign corporations as well as those who do business in California but have not registered. However, this tax is currently waived for the first year of registration.
All corporations are subject to the minimum franchise tax even if they are inactive, operating at a loss, or filing a return that covers less than 12 months.
Deciding Between an LLC, an S Corporation, and C Corporation
New business owners should understand the differences between corporations and limited liability companies (LLC). While an LLC and a C corporation are legal business entities, an S corporation is a tax status that can be elected by either of these entities. A business attorney or accountant can help you determine the most advantageous legal and tax structure for your business.
This choice also depends on the type of business you have and its characteristics, since there are legal restrictions for each type of entity. For example, a corporation that wants to elect S corporation tax status must qualify as a small business based on IRS regulations. Businesses that do not qualify will have to establish a C corporation or LLC.
Determining the best state in which to form your business entity before you register your business is less expensive than changing your business jurisdiction later. This decision depends on the characteristics of your specific situation.
Forming a California Corporation
Large companies typically form as C corporations, which offer substantial operational flexibility. They can issue multiple classes of stock, have unlimited types and number of shareholders, may elect a fiscal year that does not necessarily align with the calendar year, and can allocate income to fund growth.
C corporations report net income on IRS Form 1120, and it is taxed on a sliding scale starting at 15 percent for up to $50,000 in earnings. However, personal service corporations (PSC) such as architecture and consulting firms are subject to a flat fee of 35 percent for all profits.
The income of a C corporation is taxed both at the corporate level and when shareholders report dividend profits on their individual returns. Smaller C corporations often pay shareholders who work for the business enough salary so that no dividends are distributed, thus avoiding double taxation.
C corporations in California are taxed at a rate of 8.84 percent of their net income, with a minimum annual tax of $800 except in the first year after the corporation is established. C corporations can pay for employee health insurance before taxes. They can also establish a medical reimbursement plan on a pre-tax basis.
California corporations are governed by bylaws. The shareholders elect a board of directors that must include a CEO, CFO, and secretary. These individuals can run the business or hire others to run it. Corporations are required to hold an annual meeting. When corporations meet these requirements, they enjoy limited liability protection and tax benefits.
Corporations can avoid double taxation by:
- Electing for S corporation tax status, in which shareholders report income on their individual returns
- Income-splitting, in which part of the income is taxable to the shareholders and part taxable to the corporation itself, lowering the tax burden for both parties
Because C corporations are often more financially and legally complex than other types of business entities, plan to retain the services of a qualified attorney and tax professional.
Forming a California LLC
An LLC can be owned by any combination of individuals, corporations, and other LLCs. This entity has flexibility when it comes to allocating profits to its owners, known as members. An LLC can be managed by its members or by outside managers appointed by the members.
If you need help with deciding which type of California business entity to establish, you can post your legal need on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.