California LLC and Corporation Notes: Franchise Tax, LLC Fee, and What Owners Overlook

California is the state most often cited for high entity costs, and the reputation has a factual basis. This overview describes how the system generally works so you can plan, but it is educational, not exhaustive, and rates, thresholds, and rules change. Confirm current details with the California Franchise Tax Board and Secretary of State before acting.

The annual minimum franchise tax

California generally imposes an annual minimum franchise tax on corporations, LLCs, and certain other entities that are organized in California or doing business in California. The long-standing amount has been $800 per year per entity. It applies whether or not the entity makes a profit. That per-entity minimum is the fact that most influences structuring choices in the state: two LLCs mean two minimum payments.

Some newly formed entities have at times been given a first-year exemption under temporary legislation, but such exemptions have been limited and have ended for later formation years. Do not assume a first-year holiday without checking the current law.

The LLC fee based on total income

In addition to the minimum tax, California LLCs with total income above a threshold pay an annual fee that steps up with the amount of income. The fee tiers begin at a modest level of total income and rise with each bracket. The fee is based on total income from all sources derived from or attributable to California. It is due even if the LLC is a disregarded entity or has a loss, which surprises owners who thought a low-profit year meant a low bill.

Doing business in California

The state defines "doing business" broadly, including cases in which an entity is organized in California, is commercially domiciled in California, or has California sales, property, or payroll above indexed thresholds. An LLC formed in Nevada or Wyoming but operating in California is typically subject to California's minimum tax and LLC fee, and must register as a foreign entity. That is why the idea of avoiding California charges by forming elsewhere does not usually work for businesses that actually operate in California. See forming in Delaware or your home state and foreign qualification basics.

S-corporations in California

California recognizes federal S-corp elections but taxes S-corporations at the entity level at a rate that is lower than the C-corp rate, historically at 1.5 percent of net income, subject to a minimum. Shareholders also pay California personal income tax on their share of income. That entity-level tax can reduce the S-corp payroll tax savings relative to states with no S-corp entity tax. Run the numbers for the state before electing. See when to elect S-corp status.

Pass-through entity tax

California has offered an elective pass-through entity tax for qualifying entities, designed to let the entity pay state income tax at the entity level, which can produce a federal deduction at the entity level under the current understanding of federal rules around the state and local tax deduction limit. The program details, rates, credits for owners, and rules have changed, so consult current guidance. See pass-through entity tax.

Statement of information

California entities must file a Statement of Information with the Secretary of State on a periodic schedule (LLCs generally every two years, corporations annually, at the time of writing). Missing it can result in penalties and suspension. Be careful, as the Secretary of State and the Franchise Tax Board are separate agencies with separate requirements, and an entity can be in good standing with one and delinquent with the other. See annual reports and franchise taxes.

Suspension risk

If an entity fails to file returns or pay taxes, the Franchise Tax Board can suspend its powers, rights, and privileges. A suspended entity cannot lawfully enter into contracts and may lose rights in litigation, and contracts made while suspended can be voidable. Reinstatement requires filing delinquent returns and paying amounts due. Do not ignore notices, even when the entity is inactive.

Structuring implications

Because of the per-entity minimum tax:

Do not create entities casually. Each one carries an annual minimum and needs its own return. That matters when considering separate LLCs for each rental property or activity. Compare with one LLC or separate LLCs and series LLC explained (California does not have a general series LLC statute for domestic formation, though it has rules for foreign series LLCs registering there, so consult counsel).
Consider consolidating dormant entities. Dissolve or merge inactive entities properly. See dissolving an LLC.
Evaluate S-corp economics carefully given the entity-level tax on S-corp income.
Budget for the LLC fee in higher revenue years.
Watch state sales and employment rules, which are stricter than many states. California has strong worker classification rules affecting contractors. See contractor vs employee.

First-year checklist

Register the entity and file the initial Statement of Information.
Pay the minimum tax by the required date (payment timing rules are specific for new entities).
Register with the state's tax agencies for payroll and sales tax as needed.
Obtain local business licenses from your city or county.
Set calendar reminders for the annual tax, the LLC fee estimate, the return, and the statement of information.

A note on rates and amounts

Figures such as the minimum tax and fee tiers have been stable for years, but legislatures can change them. Use the state's own instructions as the final word and verify the current year's amounts before filing.

Getting help

If you operate in California or are considering moving your business there, an early review of entity costs and S-corp economics can prevent surprises. AE Tax Advisors can help you evaluate the numbers, and you can begin with a discovery call. For legal questions, consult a California attorney.