Key Takeaways

  • California small businesses may be subject to multiple tax types: income tax, franchise tax, employment tax, and sales tax.
  • The California Franchise Tax Board (FTB) and California Department of Tax and Fee Administration (CDTFA) are key tax authorities.
  • Sales tax applies to most tangible products and must be collected and remitted by the business.
  • Employers are responsible for withholding and paying various payroll taxes, including unemployment and disability insurance.
  • LLCs, S corps, and C corps face different tax structures and filing requirements.
  • California offers several tax credits and deductions, including the New Employment Credit and small business hiring credits.

What Taxes Do Small Businesses Have to Pay?

Owners of pass-through businesses must pay California's personal income and business taxes: the corporate tax, alternative minimum tax (AMT), and the franchise tax. Nearly all companies in California pay one of these taxes or all three. 

A pass-through business is one in which profits are “passed through” to the owners or members. Also known as a flow-through business, owners or members of these companies must pay income taxes. The businesses that generally fall into the pass-through category include sole proprietorships, partnerships, limited liability companies, and S-corporations. In contrast to traditional corporations, these businesses are exempt from corporate taxes.

If your business operates as a corporation, you must pay the corporate tax of 8.84% and the AMT of 6.65%, which prohibits writing off expenses against income.

Other small businesses must pay a franchise tax depending on the type of corporation they choose to form in California.

California State Income Tax Obligations

In addition to federal income taxes, California imposes personal income taxes on business owners based on their share of the company’s net earnings. California’s individual income tax rates range from 1% to 12.3%, with an additional 1% Mental Health Services Tax on incomes over $1 million.

Pass-through entities such as sole proprietorships, partnerships, and some LLCs do not pay income tax at the business level. Instead, the income "passes through" to the owners, who report it on their personal tax returns. C corporations, however, are taxed directly at the state level at a rate of 8.84%.

What Is a Franchise Tax?

Every business that wants to do business in California has to pay a franchise tax of $800. It is also known as a privilege tax, allowing a company to operate within a particular state. Franchise taxes are separate from federal and state income taxes. Despite the name, they are not a tax on franchise businesses, which are businesses licensed by a parent company and owned by individual business owners.

The $800 is due for each year a company is in business in California, regardless of whether the company generates any revenue or is profitable.

Sales and Use Taxes for California Businesses

California requires most businesses selling tangible goods to collect and remit sales tax, which varies by locality but begins at a base rate of 7.25%. Businesses must obtain a seller’s permit from the California Department of Tax and Fee Administration (CDTFA) before selling taxable goods.

Even if a business does not sell goods directly (e.g., online or wholesale), they may still owe use tax on out-of-state purchases of equipment or supplies used in California. Failure to register and remit sales/use taxes can result in penalties and interest charges.

Who Collects Taxes in California?

The California Franchise Tax Board collects an annual franchise tax for all businesses. This tax applies to the following types of companies:

  • LLCs (limited liability companies)
  • LPs (limited partnerships)
  • LLPs (limited liability partnerships)
  • S corps (subchapter S corporations)

Corporations in California without taxable income and LLCs that choose to operate as corporations are also subject to the California franchise tax.

Foreign entities’ such as corporations, S corps, LLCs, LPs, or LLPs organized under state law and founded in other states are also required to pay franchise taxes. California requires all foreign entities conducting business there to register with the California Secretary of State and pay the franchise taxes.

Employment Taxes and Withholding Requirements

If you employ workers in California, you’re responsible for withholding and paying several types of employment taxes, including:

  • State Income Tax Withholding (PIT): Withheld from employee wages based on state income tax brackets.
  • Unemployment Insurance (UI): Paid by employers to fund state unemployment benefits.
  • Employment Training Tax (ETT): Supports workforce training programs.
  • State Disability Insurance (SDI): Typically withheld from employee wages.

Employers must register with the Employment Development Department (EDD) and report wages quarterly. Late or incorrect filings can lead to penalties, so it’s crucial to remain compliant with employment tax regulations.

Corporate Entities: Taxed on Net Earnings or $800

A corporation is a legal entity separate and apart from its owner. The corporation is taxed like an individual. The tax rate in California is 8.84% for non-pass-through entities. For example, if a company has net earnings of $500,000, the franchise tax would be $44,200 paid to the California Franchise Tax Board.

However, if you form a business under an LLC, LP, or LLP in California before December 31, 2023, then you do not have to pay the $800 minimum annual franchise tax for the first taxable year. Before the new law, only corporations were exempt from the franchise tax in the first year after their registration with the state. This change removes an obstacle to the creation of small businesses.

Regardless of whether your corporation is operating at a loss or fully active, it must still pay the franchise tax.

Estimated Tax Payments and Filing Deadlines

California requires small business owners—especially sole proprietors, partners, and S corporation shareholders—to make estimated tax payments if they expect to owe more than $500 in taxes ($250 for individuals). These payments are typically due:

  • April 15
  • June 15
  • September 15
  • January 15 (of the following year)

Missing these deadlines can result in penalties and interest. Corporations must also make estimated payments based on their expected annual income, using Form 100-ES.

Franchise Taxes and Pass-Through Entities

In successful companies, after paying expenses and taxes, dividends are often paid to owners. This leads to double taxation, where the corporate shareholders are taxed at an individual level while the corporation’s earnings were already taxed at the corporate level.

The California tax system applies pass-through taxation to limited partnerships, limited liability partnerships, and limited liability companies are taxed as partnerships.

Limited liability companies (LLCs)

Limited liability companies also pay the franchise tax. However, they are taxed at flat dollar amounts based on the LLC's annual gross income tiers.

The level of taxation depends on the tier. For instance, a business generating a gross income between $50,000 and $99,999 pays $2,500. Small businesses still pay the minimum franchise tax of $850, even if their gross income is less than $250,000.

Business owners must pay marginal taxes on their net income at rates ranging from 1% to 12.3% for an LLC.

Partnerships

Limited liability partnerships (LLPs) and limited partnerships (LP) have to pay franchise taxes of $800. Business owners must file individual tax returns for any income that passes through those partnerships.

S Corporations

An S corporation pays a lower tax rate of 1.5% on net corporate income instead of the corporate tax of 8.84% for traditional corporations, passing the profits to the business owners. California is unusual in that while it recognizes an S-corporation as a business organization, it doesn’t recognize an S-corporation as a pass-through business.

S corporations in California have to pay a 1.5% franchise tax on net income, with a minimum threshold of $800. For example, 1.5% of an S corporation’s net income of $100,000, or $15,000, goes towards California state income tax. Further, any individual shareholder has to pay tax on their share of an S corporation's income for their personal tax returns, respectively.

Tax Credits and Incentives for California Businesses

California offers several tax credits and deductions to reduce small business tax liability. Key incentives include:

  • New Employment Credit: Available to businesses hiring qualified full-time employees in designated geographic areas.
  • California Competes Tax Credit (CCTC): A competitive tax credit for businesses that want to grow and remain in California.
  • Disabled Access Credit: Helps small businesses cover expenses related to accessibility improvements.
  • Research & Development Credit: Offsets the cost of qualified R&D activities conducted in the state.

These credits can significantly reduce your overall tax burden but require proper documentation and timely application.

Understanding business entities and taxes for small businesses

While most corporations must pay the franchise tax, S corporations are not taxed the same way. You should explore the taxation system or hire an expert to determine which entity works best for your business. You can work with an accountant and a tax attorney to better understand how to operate your business best so that you’re not paying unnecessary taxes.

Tax Filing and Compliance Tips for California Small Businesses

To stay compliant and avoid audits or penalties, small business owners in California should:

  • Register with all appropriate agencies (FTB, CDTFA, EDD).
  • Keep meticulous financial records and retain documentation for at least four years.
  • Separate personal and business finances to simplify reporting and reduce legal exposure.
  • Use accounting software or work with a CPA to ensure accurate quarterly and annual filings.
  • Understand industry-specific obligations, such as excise taxes for alcohol or fuel, or local business license fees.

Frequently Asked Questions

  1. Do all California small businesses have to pay the $800 franchise tax?
    Most do, but some new businesses are exempt in their first year, depending on their formation date and entity type.
  2. How do I register for sales tax in California?
    You must apply for a seller’s permit through the CDTFA before selling taxable goods or services.
  3. What happens if I miss an estimated tax payment?
    The FTB may assess penalties and interest on any late or underpaid estimated taxes.
  4. Are LLCs taxed differently from corporations in California?
    Yes. LLCs may be subject to both the franchise tax and an additional fee based on gross income, while corporations pay the corporate tax rate on net earnings.
  5. What payroll taxes do I need to withhold as an employer?
    You must withhold state income tax and SDI from employee wages and pay UI and ETT as an employer.

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