By: Tamara Pow
Before you form a limited liability company to do business in California, make sure you understand the California LLC taxes. Both limited liability companies (“LLCs”) formed in California, and LLCs formed in a state other than California that are doing business in California, must pay two types of tax to California for the privilege of doing business in our great state. First, like corporations, limited partnerships (“LPs”) and limited liability partnerships (“LLPs”), an LLC must pay an $800 annual franchise tax for each tax year (or portion thereof). Second, if the LLC has $250,000 or more of total gross income from all sources derived from or attributable to California in any one year, it must pay an additional fee known as the LLC Gross Receipts Fee. Total income for calculation of the Gross Receipt Fee does not include an allocation of gain or a distribution made from another LLC in which this LLC is a member. This means that if you have an LLC that has one or more LLCs as its members, the fee is paid based on total income from this LLC only, and the income is distributed or allocated to one of the member LLCs. The fee is in addition to the $800 franchise fee and is calculated on a step basis. If your LLC’s gross receipts are $250,000 or more but less than $500,000, the fee is $900. If your LLC’s gross receipts are $500,000 or more but less than $1,000,000 the gross receipts fee is $2,500. If they are $1,000,000 or more but less than $5,000,000 the gross receipts fee is $6,000. If your LLC’s gross receipts are $5,000,000 or more, the gross receipts fee is $11,790.
Deductibility: The $800 franchise fee is not deductible on the LLC’s California tax return. The gross receipts fee is deductible for California income tax purposes.
Note for commercial landlords: Commercial landlords should take note that both of these fees have been analyzed by the California Court of Appeals and have been determined to be costs to limit the personal liability of the business owner. As a result, depending on the language of the form lease you are using, a landlord may not be able to pass the costs on to tenants as part of operating expenses.
Due Dates : The $800 annual franchise fee is due on or before the 15 th day of the 4 th month of the taxable year. For an LLC formed in January, the due date would be April 15 th . For an LLC formed in February (regardless of which day in February), the due date would be May 15 th , and so on. The gross receipts fee is due on or before the 15 th day of the sixth month of the year – meaning that the LLC must estimate its expected gross receipts for the year and pay the tax accordingly. An underpayment penalty of 10% will be added to the fee if the amount paid is insufficient, unless the estimated fee is equal to or greater than the fee paid in the prior taxable year. (See California Revenue & Tax Code Section 17942(d)(1)-(2).)
Although these fees can be significant, depending on the profit margins of the business of the LLC, they could be much higher or much lower than the 1.5% of net income that California S corporations pay. Generally, businesses with large profit margins will prefer to pay the LLC fee based on revenue, whereas those with small margins (a lot of revenue but not much income) will prefer to pay tax based on net income. Of course, this comparison is only one item to take into account in determining the right choice of entity for your business. An experienced business attorney can assist you in analyzing all of the tax and non-tax considerations in deciding whether the LLC is the right form of entity for you.
Tamara B. Pow is a founding partner at Strategy Law, LLP in San Jose, California. She has been practicing LLC, partnership and real estate law in California for 20 years. Tamara uses her MBA, California real estate broker’s license and experience in public accounting, to advise business entities such as LLCs on the importance of tax planning before forming a business entity.
The information appearing in this blog does not constitute legal advice or opinion. Such advice and opinions are provided by the firm only upon engagement with respect to specific factual situations. Specific questions relating to this article should be addressed directly to Strategy Law, LLP.