If you are a startup in California and have decided to go for a limited liability company (LLC), then you are in luck. Many people view California as unfriendly when it comes to taxing businesses. Thus, many business owners think twice before they form a company in California. Who can blame them? The amount of taxes a company will have to pay surely plays a huge role on the owners’ decision on which state to open in. However, there is one thing that every business owner should know. There is a California Franchise Tax first-year exemption.
Understanding Franchise Tax
The franchise tax is something that a state levies on certain businesses. The states impose the tax for the companies’ right to exist and do business within the said area.
In California, the Franchise Tax Board (FTB) requires all limited liability companies (LLCs), limited partnerships (LPs), limited liability partnerships (LLPs), C Corporations, and S Corporations that are registered in the state to pay for a franchise tax. New businesses need to pay for the minimum franchise tax worth $800 annually.
The California Franchise Tax is due every first quarter of every accounting period of a business. It does not matter if the company is fully active, operating at a loss, or is not doing any business.
During the first year, corporations will not have to pay for the minimum franchise tax. However, they will have to pay for the applicable percentage of tax based on the net income. The tax rates are as follows:
- 8.84% for Professional Corporations
- 8.84% for C Corporations
- 1.5% for S Corporations
Meanwhile, LLCs generally pay for the minimum franchise tax amount of $800.
Exemptions to The Rule
Thinking about paying for a higher tax rate can be stressful for business owners. That is why one should research all aspects of the franchise tax. Many people do not know that there are exemptions to the rule. Currently, California has three conditions to waive the minimum franchise tax.
1. First Year Exemption
As the name suggests, the California franchise tax first-year exemption allows new corporations that qualify or have incorporated on or after January 1, 2000 with the Secretary of State to waive their first-year minimum franchise tax. The state will apply a franchise tax based on the net income of the corporation.
After this, the company will be subject to the annual minimum franchise tax of $800 starting on its second tax year. However, not all companies are eligible to get the first-year exemption. It only applies to the following:
- S Corporations
- C Corporations
- LPs
- LLPs
- LLCs that have chosen to be taxed as a corporation
Additionally, the company will not be able to waive its first-year minimum franchise tax if the Secretary of State does not qualify the company or if it has reorganized to avoid payment of the franchise tax.
LLCs that are taxed as disregarded entities have until the 15th day of the fourth month after the filing of the Articles of Organization with the Secretary of State to pay for the annual franchise tax. After the first year, they will have until the 15th of April to pay for the annual franchise tax.
2. The 15-day Rule
The 15-day rule is also known as the short accounting period. Companies that have a first taxable year that is not more than 15 days do not have to file for franchise tax if it has incorporated within the last 15 days of the tax year and has conducted no business during said days.
The state will not consider the short accounting period as the first tax year since the company did not file a return. Thus, the next year will be the company’s first taxable year. If this is your case, you can use the California franchise tax first-year exemption on the following year.
3. Tax exemption
There are business entities that can have tax-exempt status. The exemption will be based on the constitution of the state or determined by the FTB. For example, LLCs in California must pay for the minimum annual tax of $800. However, one can waive the for tax exemption if the LLC is nonprofit, it has an S Corporation status, and if it is under the exclusive ownership of a deployed US Armed Forces member that cannot conduct the business activity for a short duration of time during the year.
What to Expect
Currently, the law on the first-year exemption does not state any provision on when it will expire. Many attempts have been made to modify the system. However, there are no pending legislations related to this exemption. The best thing you can do as a business owner is to check if your new company is eligible for a first-year franchise tax exemption. If you are, then you will be lucky to have the opportunity to take advantage of the said law.
Understanding the franchise tax law is important to ensure that your business will comply with the laws that the state has set. If you are in doubt, you can always research online. Check the website of the FTB or the Secretary of State for more details. It will also not hurt to consult with legal and financial professionals to deal with your taxes.
If you are thinking of forming a company in California, this information is something that you should also know. However, some business owners tend to overlook tax laws since they are too busy dealing with other responsibilities and focusing on the registration process. Fortunately, you do not have to face everything alone. You can rely on an experienced company like DoMyLLC to assist you as you go through the process. This way, you can focus more on finding ways to grow your business. You can also ask our team to discuss with you the aspects and the things you will need to prepare for after you get the approval of the Secretary of State to conduct business in California.
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