Considering starting a business in California and are unclear on the state costs associated with doing so? Let’s see if we can clarify the taxes and fees California charges LLCs and corporations.
The problem faced by every person considering starting a business is what type of business entity should you select and, just as importantly, what are the fees and taxes associated with the different options? Get it right, and you can limit the amount you pay each year. Get it wrong and tax season can be far more painful than it needs to be.
The corporation is by far the most popular business entity in the world. The California tax authorities certainly love it. If you form a corporation in the state, you must pay 8.84 percent of your net profit each year as tax. However, there is a twist.
California also mandates an annual minimum tax of $800 for a corporation. This fee is paid if the total tax calculated from your net profit is less than $800. For example, if you make a profit of $1,000 in 2014, the tax would be $88.40. Since this is less than $800, you would need to pay the $800 minimum tax instead.
New corporations get a bit of a break on the minimum $800 tax. The minimum tax does not apply to the first year of the existence of the corporation. Let’s return to our example of a profit of $1,000 in 2014. The new company would only need to pay the $88.40 tax and not the $800 minimum. This adjustment can be a big boon for businesses getting off the ground with very little capital.
Commentators promote the limited liability company as being small business friendly, even going so far as to suggest you do not need an operating agreement to run one. In some ways it is, but California offers up a few nasty surprises to the unwary when it comes to these entities.
An LLC faces the same $800 minimum tax as a corporation in California. The primary difference is the LLC does not get a “free” first year. Not only must the minimum tax be paid regardless of whether there is a profit in the first year, it must be paid by the 15th day of the 4th month after forming the LLC. You don’t even get a year!
Why the difference between the LLC and corporation? There is no logic to it. A cynical person might suggest politicians assumed owners of smaller businesses might rush into an LLC without realizing the fee situation is worse than the corporation, but I digress.
The taxation of an LLC is dependent on the designation the owners make with the IRS. The entity can be taxed as a partnership, corporation, s-corporation or a sole proprietorship if there is only one owner. You should always consult with a CPA in making the choice because the difference between choosing the correct designation for your particular business will be the difference between paying a lot or a little each year.
Unfortunately, there is another fee associated with the California LLC very few people are aware of until their first tax return. The “LLC gross revenue fee” is an additional cost created for no other reason than generating revenues for the state. Importantly, this fee is based on your total earnings, not the net profit of the company. A tiered approach is used to determine the cost:
- $0 to 249,999 in gross revenues = $0 Fee
- $250,000 to $499,999 in gross revenues = $900 Fee
- $500,000 to $999,999 in gross revenues = $2,500 fee
- $1,000,000 to $4,999,999 in gross revenues = $6,000 fee
- $5 million or more in gross revenues = $11,790 fee
Again, these figures are based on gross revenues. If you bring in $700,000 in a year, but are not profitable, you still must pay the $2,500 fee.
Many people select a business entity on a whim and end up paying taxes and fees through the nose because of it. Let’s be clear. There is no perfect entity for every business. In some cases, an LLC is the superior choice for starting an e-commerce business in California while a corporation is the obvious answer for a social media site. Professional advice is the key to making the correct decision.
Do you need to select and form a California corporation or limited liability company? Contact me now to get started.
Richard A. Chapo, Esq.