Understanding Business Tax In California And How It Works
Businesses in California should plan to pay State Income Tax to the California Franchise Tax Board. Most businesses will pay a corporate tax, a franchise (or privilege) tax and/or an alternative minimum tax. In addition, California is one of the few states to impose a state tax on personal income from pass-through entities.
Types Of California Business Taxes
There are three categories of taxes for Small Businesses in California.
Corporate Tax A
Corporate Income tax is a tax on the profits of a business calculated on taxable income after expenses have been deducted. In California, C Corporations and LLCs taxed like a corporation that report a net income pay the corporate tax at the rate of 8.84%.
Franchise tax is also called privilege tax for the privilege of doing business in CA. It is collected as a minimum fee, a flat fee or a percentage based on the entity structure of the business.
Alternative Minimum Tax
The AMT is the minimum percentage a business will pay in state taxes. C-Corporations or LLCs taxed like a corporation may pay an AMT.
Types Of Businesses Operating In California
The California State Tax liability for a business and its owner(s) depends upon the entity structure and the income level of the business shareholders, owners or partners. Based on whether your business is a C Corporation, an S Corporation, an LLC, a Partnership or a Sole Proprietorship, you’ll have a different state tax structure.
As the most common business entity in the US, the C Corporation is the most flexible structure in terms of ownership and shareholders. The income from a C Corporation remains separate from its owners and is charged its own income tax.
If a C Corporation reports a net income, the Corporate tax rate of 8.84% will be owed to the state. If a C Corporation does not report a net income, the corporation will owe the AMT of 6.65% or the Franchise Minimum Tax of $800 (whichever is higher).
For instance, a C Corporation with a net income of $10,000,000 will owe $884,000.
An S Corporation is similar to a C Corporation in its ownership, management and legal protection. However, the S Corp is a type of pass-through entity with specific restrictions including no more than 100 shareholders in one class of stock. For federal tax purposes, the shareholders pay the tax on this type of entity, not the business. For CA state tax purposes, both are taxed.
California businesses defined as an S Corp will pay a 1.5% franchise tax on income, with a minimum tax of $800 even if the net income is zero. Shareholders will also owe state tax on their portion of the company’s income.
For example, if an S Corp had a net income last year of $1,000,000, the corporation will owe a state tax of 1.5% of $1,000,000 ($15,000) and each stockholder would pay state tax on their portion dependent upon the rate for their respective income level.
Limited Liability Companies (LLCs)
An LLC is also a pass through entity with owners rather than shareholders. Just like the S Corp, the owners pay federal and state tax on their income. The business income is not taxed federally however it is subject to CA state tax.
Standard LLCs in CA are taxed a flat rate according to tiers of gross income with a minimum of $800 franchise tax. LLCs that are classified as corporations are subject to tax based on whether or not they show a net income. With a net income, they pay a corporate tax (8.84%) and without a net income they pay an alternative minimum tax (6.65%) in CA. LLCs that are classified as Partnerships pay the $800 minimum franchise tax when they do not have net income or pay a flat rate according to tiers of gross income when they do have a net income.
For example, an LLC classified as a Partnership has a net income of $60,000 would have to pay the minimum $800 franchise tax. In addition, the owners would pay tax on their portion dependent upon the rate for their respective income level.
In General Partnerships where income is distributed to the individual partners, each partner pays personal income tax on their portion of the income and there is no additional business tax. A Limited Partnership (LP) or Limited Liability Partnership (LLP) must pay a flat $800 franchise tax regardless of income level.
So if a Partnership that’s not an LP or LLP had a net income of $100,000 last year, the income would be distributed between the partners and each would pay tax on their portion dependent upon the rate for their respective income level.
In a Sole Proprietorship, the income is distributed to the single owner who pays tax on their income dependent upon the rate for their respective income level. There are no additional business taxes.
Tax Deductions For Businesses In California
Keeping track of business expenses in bookkeeping software may prove more profitable than claiming the standard deduction towards your taxable income. Any unreimbursed expenses you spend money on can count. Here are some examples:
- Business meals and use of your car
- Home office costs
- Real estate taxes
- Legal and professional fees
Why It’s Important To Prepare For Your Taxes As Early As Possible
If you are wondering if you should switch entities or which deductions you can claim, now is the time to sit down with a Certified Tax Coach to strategize and lower your tax liability. Approaching your tax bill proactively will allow you peace of mind knowing you can spend your time running your business rather than reacting to an unexpected tax burden.
How To Pay State Business Taxes In California
Just as the IRS requests quarterly payments, you also pay quarterly statements to the CA Franchise Tax Board (FTB) if you expect to owe at least $500 in CA State Taxes. The FTB splits the payments up differently from the IRS, however. The first quarter payment due mid-April is 30%, the second quarter payment due mid-June is 40%, the third quarter payment is 0% and the fourth quarter payment due mid-January is 30%.
How To Get A Tax Extension
All business entities in California receive a filing extension for six months from the original due date without having to submit a written request. The automatic extension, however, does not extend the time for payments.
How To Optimize Your Corporate Tax Strategy
Meet with a tax advisor early and often to discuss the tax strategies that will work best for your business. An effective tax advisor should ensure the maximum deductions are being taken and discuss the tax ramifications of business decisions. as well as check in often to confirm tax compliance.
Let Us Help You Build a Better Business
The best strategy when it comes to corporate taxes in California is to have a plan. Tax experts can help you reduce your tax liability and increase your profitability.