What is the California Franchise Tax?
Under California law, all corporate entities must pay an annual franchise tax. The minimum amount due is $800. The tax is collected by California Franchise Tax Board and applies to the following:
- LLCs (Limited liability companies);
- S-Corps (Subchapter S corporations);
- Professional corporations (e.g., law, medical, psychology, etc.);
- LPs (Limited partnerships); and
- LLPs (Limited liability partnerships).
The only corporate entities that do not pay the franchise tax are tax-exempt nonprofit organizations.
The franchise tax is also paid by corporations, S-Corps, LLCs, LPs, and LLPs organized under other state laws, or “foreign entities” as they are commonly called. To conduct business in California, foreign entities must register with the California Secretary of State and are subject to the franchise tax just like business entities formed under California law.
Corporate Entities: Taxed on Net Earnings or $800
Corporations in California are entities that have legal existence separate and apart from the individuals who own them. Just like individuals, corporations must pay taxes. In California, for non-pass-through entities, the tax rate is 8.84% of the net annual earnings. So, if a new company has net earnings of $100,000, the annual franchise tax paid to the California Franchise Tax Board would be $8,840.
$800 is the minimum annual franchise tax (which is waived the first year). So, if during the first year, a new company has net earnings of just $1,000, the annual franchise tax would be $8.84. However, if during the second year, the net earnings are again $1,000, now the franchise tax is $800.
The minimum annual franchise tax must be paid whether your corporation is fully active, operating at a loss, or is not doing any business at all.
It is vital for all corporations to pay their franchise taxes (and complete the annual filing reports). As we wrote recently, failure to pay can have serious legal consequences. See Cal-Western Business Services, Inc. v. Corning Capital Group, 221 Cal.App.4th 304, 163 Cal.Rptr.3d 911 (2nd Dist. 2013).
Avoiding Double-Taxation: Pass-Through Entities
When corporations have a successful year, after paying expenses and taxes, the company will often pay out dividends to the owners. When that happens, the shareholders of the company incur income-tax liabilities for these payments at an individual level, even though the earnings were already taxed at the corporate level. This is the so-called “double-taxation” problem.
However, some corporations in California can elect to be classified as “S corporations” which provides a reduced annual tax rate on net corporate income (1.5% instead of 8.84%). The “double-taxation” is not completely avoided, but there is a substantial tax savings.
The special tax status of S corporations is intended for small businesses. Thus, not every business is eligible to make the S corporation selection. To be eligible, an S corporation:
- Cannot have more than 100 owners;
- Cannot have a nonresident alien as an owner;
- Cannot have more than one class of stock; and
- All owners must unanimously consent to the election each taxable year
Limited partnerships, limited liability partnerships, and LLCs are generally taxed as partnerships, which is pass-through taxation similar to S-Corps, but partnerships and S-Corps are not taxed identically in California.
When is the California Franchise Tax Due?
For most companies, the franchise tax is due before March 31st of the calendar year. However, if your company uses a non-calendar-year accounting period, then the tax is due during the first quarter of your fiscal year.
Contact San Diego Corporate Law
For more information, contact Michael J. Leonard, Esq., of San Diego Corporate Law. Mr. Leonard has been named a “Rising Star” in San Diego from 2015-2017 by SuperLawyers. Contact Mr. Leonard by email or by calling (858) 483-9200.