1. How the IRS Taxes LLC Members
2. Electing Corporate Taxation
3. Business Income Tax in California
4. How to Escape the Franchise Tax of California 

The LLC minimum tax is exemplified by the minimum $800 payment that limited liability companies, which are legally qualified to do business in California, make to the state government annually. It's also called a "franchise tax" in California and some other states. States charge different rates, but this tax is based on the net worth of the LLC's capital instead of its income. 

How the IRS Taxes LLC Members

LLCs aren't taxable organizations like corporations. Rather, the IRS describes them as “pass-through” entities, similar to sole proprietorships or partnerships.

That's because their profits and losses “pass through” the business to the owners, who are known as members and provide their business income data on their individual tax returns.

The IRS considers an LLC a partnership or a sole proprietorship, depending on how many members it has. A single-member LLC works like a sole proprietorship and doesn't file tax returns with the IRS. Instead, the owner of the LLC submits profit and loss information with their 1040 tax returns, on Schedule C. Even if they reserve profits in the bank at the end of the year to run and grow their business in future, the reserved money is taxable.

The IRS deals with LLCs with multiple owners as partnerships for tax reasons. Like single-member LLCs, they don't pay corporate income taxes. Instead, their owners individually pay taxes on how much profit they make from running the LLC, with Schedule E attached.

The IRS assumes that LLC owners receive their complete distributive shares annually. So, they're each required to pay taxes accordingly, whether the LLC completely distributes the shares or not.

Though multiple ownership LLCs don't pay taxes, they have to provide accurate information for the IRS on Form 1065, which the IRS verifies. Each member of the LLC must get a Schedule K-1 from their LLC to enable them to clearly document their individual shares of profits and losses. That way, they can report their profits and losses via a personal Form 1040 with Schedule E attached.

Electing Corporate Taxation

LLC owners who mostly keep significant amounts of profits in their LLCs (called “retained earnings”) can take advantage of “electing corporate taxation,” which came into effect for “C” corporations in 2018.

Electing corporate taxation is an LLC's request to be recognized as a taxable, corporate entity. The LLC only has to file Form 8832 for the IRS to change their entity classification.

Electing corporate taxation has the advantage of reducing an LLC's taxes by charging a flat 21 percent tax on its collective profit, instead of each member paying 32 percent or more. The disadvantage of electing corporate taxation is that it doesn't exempt shareholders from paying their individual taxes, resulting in double taxation. However, electing corporate taxation allows LLC owners and employees to enjoy stock ownership plans, stock options, and other benefits, which aren't liable to double taxation.

Unlike employees, LLC members don't contribute to Medicare and Social Security. However, they pay self-employment taxes from personal profits, except those who aren't actively serving the LLC and making executive decisions. LLC members pay twice the amount regular employees pay in taxes because employers pay half the tax for their employees.

Most states treat LLCs as the IRS does. Therefore, LLCs don't pay taxes to the states. Instead, LLC members pay taxes individually. However, some states tax LLCs according to their corporate revenue in addition to the taxes the individual owners pay. For example, California levies LLCs between $900 and $11,000 if they make over $250,000 annually.

Furthermore, some other states impose yearly, non-income fees on LLCs, which may be called “an annual registration fee,” “a franchise tax,” or “a renewal fee.” Most states charge LLCs $100 annual registration fees, but California charges a whopping $800 “minimum franchise tax” annually.

Business Income Tax in California

The franchise tax of California, which is a tax on running a business in California, is applicable to S corporations, limited partnerships, C corporations, limited liability partnerships, and LLCs electing to be considered corporations.

How to Escape the Franchise Tax of California 

There are two ways to escape the $800 franchise tax of California:

  •  Be a sole proprietor. This has a disadvantage of denying you liability protection of personal assets.
  • Incorporate in another state where there's no corporate income tax and cancel your qualification for business in California. 

LLC taxes can be cut, but going it alone might land you in serious trouble. To play it safe, you need competent, legal help.

If you need more help understanding the LLC minimum tax in your state, post your legal need on UpCounsel. 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.