If you are starting a business in California you may be surprised to learn that California business entities must pay a minimum franchise tax to the state each year – even if the business is inactive or loses money.
At $800, the annual tax fee can feel like a lot of money to a cash-strapped startup. Fortunately, there are ways to minimize the tax if you are starting a business during the last months of the year.
Who Must Pay the California Tax Franchise Fee?
California business entities must pay the $800 minimum franchise tax each year, even if they don’t conduct any business or operate at a loss. Types of businesses that must pay the minimum tax include:
- S corporations, C corporations, LLCs, limited liability partnerships and limited partnerships that are formed in California.
- Out of state business entities that are registered with the Secretary of State to do business in California.
- Out of state business entities that do business in California, even if they are not formally registered. In general, a business is “doing business” in California if it engages in transactions in California for financial gain or if it meets other criteria such as having a certain amount of sales or property or paying a certain amount of compensation in California.
- Sole proprietorships and general partnerships do not have to pay the fee.
The $800 tax is a minimum. Profitable business entities may pay additional corporate taxes or an LLC fee based on the amount of profits.
When are the LLC Fees and Corporation Fees Due?
The first year’s franchise tax fee is due no later than the fifteenth day of the fourth month after the business entity was formed. After that, the annual fee must be paid by April 15th. Thus, if you formed an LLC on June 1st, the first annual fee would be due on October 15th, and the second year’s fee would be due on April 15th of the following year.
But the first and second year’s fees can come due at about the same time for a business entity formed near the end of the year. Suppose you form an LLC on November 15th. You’ll still be responsible for the full $800 first year fee – the Franchise Tax Board does not reduce or pro-rate the fee for businesses formed in the last half of the year. To make matters worse, your first year’s fee will be due on March 30th of the following year, but you’ll have to pay the second year’s fee just over two weeks later, on April 15th. That’s a $1600 tax bill in your first few months of business.
This double billing can mean that the cost to start a business in California is more than you budgeted for.
How to Avoid Double Billing of the Franchise Tax Fee
The CA Franchise Tax Board does not charge a first year fee for new businesses formed in the last 15 days of the year. Therefore, a business formed at the end of December will only be responsible for one $800 payment in April. A business formed at the beginning of the new year will also only be billed for one year’s fee in April.
If you are able to wait until after December 15th to file your business formation or registration paperwork, you can avoid double billing of the franchise tax fee and save your business $800.
Some business owners try to avoid the franchise tax fee altogether by forming a business in another state. This can be a good idea if you and your business have no other connections to California. But remember that California imposes the fee on all business entities that are doing business in the state. If your company will be transacting business in California, it will have to pay the fee even if it was formed in another state.
How much does it cost to start a business in California? In addition to the cost of filing formation paperwork, you must factor in the $800 minimum California Franchise Tax Fee. If it’s near the end of the year, consider waiting until the new year to file your organizational documents so that come spring, you’ll only owe one year’s fee instead of two.