By The Wyoming LLC Attorney Team
Feb 29, 2024You may wonder if it is necessary for any LLC in California to pay income tax. The short answer is yes. However, California differs from a lot of other states and it is worth exploring the fine print for this state.
Limited Liability Companies (LLCs) operating in California are subject to a mandatory annual franchise tax of $800 and an additional LLC fee based on their gross receipts. Regardless of their net income, the franchise tax applies, and its purpose is not to serve as a state income tax.
Moreover, an LLC is considered to be conducting business in California if it transacts within the state for financial gain, is legally organized there, or if at least 25% of the LLC's sales, property, or payroll stems from California. Even if a company simply sells goods to California customers without any other ties to the state, the LLC fee based on gross receipts still applies.
While LLCs enjoy federal tax benefits due to their pass-through taxation structure, their California state tax structure is notably different. The owners of an LLC pay taxes based on their individual rates and their interest in the company. For single-owner LLCs, a separate federal income tax return is not necessary—the owner directly reports the LLC's income and deductions on their own return.
In contrast, C corporations are subject to double taxation—federal income tax applies at the corporate level, and owners must also pay tax on dividends and capital gains. Despite the option for LLCs to pay tax like a C corporation, most choose not to due to this double taxation.
The franchise tax in California is a mandatory annual payment of $800 that all LLCs operating in the state must make. However, there are a few exceptions. For instance, LLCs that have not conducted any business in California during a tax year of 15 days or less are exempt from the franchise tax.
One of the taxes that LLC owners may have to pay is the self-employment tax. This tax is a contribution towards Social Security and Medicare, and it applies to the profits of the LLC. Meanwhile, estimated taxes are payments made throughout the year on income that is not subject to withholding. These include earnings from self-employment, interest, dividends, rent, and alimony.
Paying your California state tax on LLCs involves several steps.
Unless an LLC selects a different fiscal year, tax returns are due on April 15, similar to individual tax returns. The franchise tax payment should be made by the fifteenth day of the fourth month of the current tax year, while the LLC fee is due by the fifteenth day of the sixth month.
The amount of tax an LLC pays in California varies based on the company's gross receipts. For example, an LLC with a total income between $250,000 and $499,999 must pay a fee of $900. This amount increases as the total income grows, with the maximum fee of $11,790 applied to LLCs with a total income exceeding $5,000,000.
An LLC that elects to be taxed as a corporation does not need to pay the additional LLC fee. However, this election only applies at the federal level, making it impossible for an LLC to select pass-through taxation for federal income tax and corporate taxation for California state tax.
Despite the obligations of franchise tax and an LLC fee, there are certain tax benefits for LLCs in California. For one, they enjoy pass-through taxation, allowing business income and losses to flow directly to the owners, who report them on their individual tax returns. This helps avoid the double taxation that C corporations face. Furthermore, an LLC can deduct the cost of operating expenses, thereby reducing its taxable income.
In California, certain exemptions apply to newly formed LLCs. If an LLC is canceled within one year of formation, it is exempt from the franchise tax for the first year.
Completely avoiding LLC tax in California is challenging given the mandatory nature of the franchise tax and LLC fee. However, there are legal strategies to minimize your tax burden. These can include careful structuring of business expenses and taking advantage of legitimate tax deductions and credits. Consulting with a tax professional can provide more personalized strategies.
While the focus is often on state taxes, don't forget that California LLCs are also subject to federal taxes. The key distinction is that, on a federal level, most LLCs benefit from pass-through taxation, meaning that the LLC itself does not pay income tax. Instead, income and losses are passed through to the owners, who report these amounts on their personal tax returns.
Understanding the nuances of LLC taxation in California can be complex, but it's crucial for ensuring your business meets its legal obligations while maximizing its fiscal efficiency. Whether you're just starting an LLC or you've been in operation for years, it's always advisable to seek professional advice to navigate the complexities of taxation. To seek further assistance in establishing your California LLC, please feel free to fill out the contact form or call +1 (307) 683-0983 to connect with one of our knowledgeable paralegals.