Looking to start an LLC in California? Compared to many other states, California’s laws related to LLCs (and especially the taxation of LLCs) are somewhat complex. With this in mind, there are some things you should know before you file for an LLC in the Golden State.
From annual franchise taxes to additional LLC fees based on income, this article offers a practical overview of the California LLC taxes and filing requirements you need to understand as a business owner.
How California taxes LLCs
In California, taxation of LLCs is dependent on two factors:
- State-specific rules
- Federal tax classification
In general, most single-member LLCs are taxed as sole proprietorships by default, whereas multi-member LLCs are usually taxed as partnerships. For LLCs that have elected for S corporation or C corporation structures, the company is subject to the state’s corporate tax rate.
No matter business structure or federal tax treatment, however, California imposes state-level LLC taxes and fees for every LLC operating in the state — even if the business is inactive or only operates for a portion of the year. This is known as the annual franchise tax, which is a flat rate of $800 per year.
Do you have to pay the $800 California LLC fee every year?
One of the most common questions business owners have about California’s franchise tax is whether it is required to be paid by all LLCs annually. The simple answer to this is that yes, most California LLCs must pay the $800 franchise tax each year.
This remains true regardless of whether the LLC is inactive for part of the year, earns very little income, or has been dormant for the entire year. As long as the LLC is still filed and legally operating within the state, the fee is due.
Business owners in California can use Form 3522 for payment. Using this tax voucher, LLC owners should submit the $800 via check or money order payable to the “Franchise Tax Board.” From there, the form and payment can be submitted by mail to the following address:
Franchise Tax Board
PO Box 942857
Sacramento, CA 94257-0531
The payment is due by the 15th day of the fourth month of the taxable business year for LLCs. For calendar-year businesses, then, this payment is due by April 15. Submitting your payment by the due date is critical if you want to avoid penalties, fees, and interest.
When do California LLCs pay an additional LLC fee?
In addition to the $800 annual franchise tax required of most LLCs in California, some businesses may also be required to pay an additional LLC fee based on their annual income in the state. Specifically, these fees begin to apply to LLCs earning $250,000 or more in annual income. It is important to note that these fees are in addition to (not in lieu of) the $800 franchise tax.
Fees vary based on an LLC’s annual income, and are structured as follows:
- $250,000 to $499,999: $900 fee
- $500,000 to $999,999: $2,500 fee
- $1,000,000 to $4,999,999: $6,000 fee
- $5,000,000 or more: $11,790 fee
The annual income for these ranges is based on gross receipts, with payments due at the same time as the annual franchise fee (April 15 for most businesses). Payment can be made using the IRS Form 3536 – Estimated Fee for LLCs.
As with the franchise see, penalties and interest will be charged for underpayment or late payments. You can learn more about these fees on the State of California Franchise Tax Board website.
Do LLCs pay income tax in California?
In California, LLCs aren’t always taxed the same way as corporations, which can create some confusion when it comes to income tax. By default, business profits and losses for LLCs “pass through” to California business owners. From there, those losses are reported on the owners’ individual tax returns.
However, specific income tax requirements will depend on how an LLC is classified both federally and at the state level. There is also the option for LLC owners to opt for California’s pass-through entity elective tax (PTE), which means paying a 9.3% tax on eligible net income in exchange for a matching personal income tax credit.
This California LLC tax payment arrangement isn’t ideal in all circumstances, however, so business owners are encouraged to consult with a professional before choosing PTE.
Likewise, business owners should keep in mind that regardless of their pass-through status, they may still owe income tax at the federal and/or state levels—as well as self-employment taxes (depending on the structure of the business).
What counts as “doing business” in California?
Even if your business doesn’t have a physical office in the state, you might still need to pay LLC tax California if you are considered to be doing business there. Because the state’s rules around nexus and “doing business” are broader than many business owners expect, understanding when you’re required to pay taxes can be challenging.
However, there are many situations that could trigger the obligation to pay LLC taxes California, including:
- Operating or managing the business in California.
- Having significant sales activity within the state.
- Hiring employees or contractors working in California.
- Owning business-related property within the state.
Likewise, if your business sales in California exceed certain thresholds, you may be considered as “doing business” in the state and thus subject to taxes.
California LLC tax filing requirements
To pay your California tax obligations, you’ll need to file an annual tax return with the Franchise Tax Board using Form 568 – Limited Liability Company Return of Income. On this form, you’ll report such information as your total business income, LLC tax, and pass-through entity elective tax (where applicable) to calculate your total amount due.
In addition to Form 568, remember that you may also need to file Form 3522 and Form 3536 to make your annual franchise tax payments and any other required tax payments. Likewise, even if you already filed and paid those taxes, you’ll still need to file Form 568 by the required deadline (April 15 for most businesses) to be subject to penalties and fees for missing deadlines.
Common mistakes California LLC owners make with taxes
California LLC tax can be confusing, and it’s not uncommon for business owners to make mistakes—especially when filing and paying state of California LLC tax for the first time. To mitigate your risk of a tax error and subsequent penalties, it can be helpful to familiarize yourself with such common errors as:
- Forgetting to submit your $800 annual franchise tax payment.
- Assuming an inactive or dormant LLC is exempt from California franchise tax (this is typically not the case).
- Failing to file Form 568, even if you’ve already paid your required taxes and filed the necessary forms for each.
- Underestimating your LLC fee obligations, which could result in underpayment and added interest/fees.
- Mixing your business and personal finances, which can lead to confusion when it’s time to calculate and file your business taxes.
How California LLC taxes compare to other states
Compared to many other states, California’s LLC taxes are notorious for being rather complex. Specifically, California’s annual franchise fees are comparatively high—especially when you consider that many states don’t charge annual franchise fees to LLC at all. Meanwhile, because California imposes flat taxes, annual taxes, and income-based fees for many LLCs, overall tax burdens for businesses operating in the state can add up quickly.
With all this in mind, those thinking about forming an LLC in California should carefully weigh their options, being sure to consider both legal and operational factors. In some cases, it may make more financial sense to form an LLC in another state. However, in taking this route, it is still possible that an LLC could be considered as “doing business” in California under certain circumstances (and thus subject to certain taxes).
Stay organized and avoid surprises with your California LLC
Forming an LLC in California can be a sensible choice for business owners who want to protect themselves from personal liability in their everyday operations. At the same time, of course, running an LLC in California can come with some significant tax burdens. On top of the annual $800 franchise tax required of most LLCs, you might also be on the hook for additional income-based taxes and fees.
Likewise, because making mistakes in filing and paying your California LLC taxes can be costly, it’s important that you understand and follow all filing requirements or seek guidance from an experienced professional around tax time.
By taking the time to familiarize yourself with how California LLC taxes work before you even file your LLC, you can stay better organized and avoid surprises down the road.
At Tailor Brands, we help many business owners looking to start LLCs in California with everything from LLC formation and EIN management to business setup and organization. Our knowledgeable and experienced team can also help you keep important compliance and financial information organized as your business grows, keeping you on-track and on top of your finances.
Interested in learning more about what Tailor Brands can do for your California business? Reach our team at (332) 286-2770 to get started!