California Business Tax Guide for Small Businesses

When you think about the tax responsibilities associated with your business, you probably picture federal taxes related to the Internal Revenue Service (IRS), which is understandable. Preparing and filing your federal business tax return is an important part of operating, but don't forget about state taxes. While most states have some commonality in their tax rules and regulations, they can also be distinct, like in California. Whether you're considering establishing your business in California or have just launched, it's essential to understand how California's state tax rules might impact your business. Use this blog as your guide to the fundamentals you’ll need to learn to prepare and file your small business tax return in California.

What to Know About Small Business Taxes in California

California is a beautiful state and a popular place to establish a small business. However, as attractive as California can be for businesses, it has multiple income tax rates and strict rules to abide by. How these rates impact your business will depend on your selected business entity. While certain entities, such as LLCs and S corporations, avoid being taxed twice due to pass-through taxation, this isn't the case in California. If your business meets specific criteria, you can expect to be subject to double taxation, meaning your business's tax bill will be up to double what it might be in another state. While establishing a business in California offers numerous advantages, tax considerations and onerous regulations have created opportunities for competing states to seize entrepreneurial investments. 

Corporate Taxes in California

California imposes three layers of taxes on businesses headquartered in its state, including:

• Corporate taxes are applied to the profits of corporations and any LLC that chooses to be treated as a corporation. 
• Franchise tax or privilege tax is paid by businesses that want to conduct business in a different state.
• The alternative minimum tax is a percentage of taxes paid to the local government, whether or not deductions can be applied.

C Corp Taxes in California

C corporations in California may not need to pay a franchise tax but are subject to a corporate tax rate of 8.84% of net taxable income. This corporate tax rate is the same flat rate for all businesses recognized by the state as corporations for tax purposes. Businesses can write off eligible expenses to make deductions from their net taxable income under that rate, but there’s a catch. California limits a corporation's ability to claim deductions with an alternative minimum tax of 6.65%.C corporations can deduct expenses from their taxable income but cannot reduce their tax burden below the alternative minimum. You can measure your alternative minimum tax rate by applying it to your adjusted gross income without all of the same deductions.

S Corp Taxes in California

An S corporation is a business entity with a special tax status approved by the IRS. Corporations of a smaller size can apply to be treated as pass-through entities at the federal level. This means that the S corporation will not pay taxes on business income as its own entity, but that income will pass through to shareholders, who will pay for that income on their own tax returns. States vary in how they treat S corporations, however. In California, S corporations don’t pay the corporate tax rate but must pay the California franchise tax as a fee for doing business in the state. The state franchise tax in California is 1.5% of net income for S corporations, with a minimum payment of $800. Even with no recorded income, every S corporation in California must pay a minimum of $800 for the franchise tax.After the franchise tax payment, the S corporation's income still passes through to the business owners to be filed on their personal tax returns.

LLC Taxes in California

Most limited liability companies in California will have a tax situation similar to S corporations, but not all. If your business entity is an LLC, you have a certain degree of control over how the state recognizes your business. If your LLC elects to be treated as a corporation, you will pay the corporate tax rate or alternative minimum franchise tax C corps pay to the franchise tax board. Other LLCs will pay the state franchise tax, allowing business income to pass through to be taxed at personal income tax rates. The franchise tax for LLCs still requires a minimum fee of $800, but otherwise, it is calculated differently than for S corps. Instead of paying a flat percentage of net income, LLCs pay a specific and pre-set franchise tax amount depending on their gross income level. The franchise tax is $900 for LLCs with gross income between $250,000 and $499,999. It steadily increases at each tier, up to a maximum franchise tax of $11,790 for gross income above $5 million. 

Partnership Taxes in California

California businesses using a partnership as their business entity might not have to pay any annual business tax in the state. It will depend on the specific kind of partnership. All partnerships still qualify as pass-through entities in that individual owners must file and pay tax on business income on their personal tax returns. Limited liability partnerships (LLPs) filed with the state must pay the franchise tax minimum of $800. General partnerships without limited partners are exempt. In a general partnership, the business's income is immediately and directly distributed among the business owners. These partnerships are not subject to the franchise tax and are treated as sole proprietorships.

Sole Proprietorship Taxes in California

If you don't fit into the other categories, your business entity may be considered a sole proprietorship. A sole proprietorship is a small business owned entirely and directly by an individual. The business owner might hire contractors or employ others, but its debt and income go through the owner. A business with a single owner does not exist outside the owner, so sole proprietorships do not pay business taxes. All income for the business is paid and filed on the individual’s personal tax return. 

Personal Income Tax

Personal income tax in California is a progressive state income tax with marginal tax rates ranging from 1.0% to 12.3% for the highest brackets. Sole proprietors and other business owners operating pass-through entities will use these rates for all of their business income. 

Multistate Taxes

If your business operates or sells goods or services in multiple states, you may owe corporate income tax in each of those states. The tax you owe in each state will depend on the revenue you earned in that state. California businesses that owe taxes across states can participate in California’s multistate offset program. This program allows California and other states to directly transfer your tax refund in one state to pay off your tax burden in another state.

Filing Small Business Taxes in California

When you file your California business taxes will depend on your entity type. For example, general partnerships have a different tax filing date than C corporations, but both adhere to the same quarterly tax payment schedules.

Check with the California Franchise Tax Board for more details about due dates that impact your business. Once your business materials are ready for submission, you can typically e-file or file by mail. While the state can quickly receive files transmitted electronically, sending your taxes in the mail can take much longer. Because of this, the California Franchise Tax Board also details overnight/express delivery options.

Partner With a California Business Tax Specialist

Handling your business's California tax obligations is incredibly complex and time-consuming. You not only have to prepare your materials while avoiding costly mistakes and submit them by their respective due dates, but you also have to keep up with ongoing tweaks and changes to California's complex tax rules. Many California-based business owners don't have the time or capacity, which is why they trust 1-800Accountant, America’s leading virtual accounting firm, for their financial needs. Whether you need business tax preparation, entity formation, or any of our professional accounting services, we have the affordable solutions you need to ensure your business remains compliant. Schedule a quick consultation–usually 30 minutes or less—to learn more.