California Does Something Right (Temporarily) for Small Business

California’s minimum tax on business entities is $800.00 per year. The California Franchise Tax is the highest in the nation and also comes with corporate income tax and personal income tax. California traditionally is a tough state to own a small business due to all the taxation and ever-changing business regulations. Interestingly, corporations have been exempted from that high fee for their first year of business since 1998. However, only 75% of about 100,000 new corporations that are formed each year claim the exemption because of complicated tax filing requirements. And don’t forget, California demands you pay the business entity tax if you are “doing business” in California. Many people mistakenly believe that if they don’t specifically have a California LLC then this tax does not apply, but that is not the case. The definition of “doing business” in California is extremely broad. You are subject to this tax if you (among other things):

• Engage in any transaction for the purpose of financial gain within California. (Even if you don’t live there.)
• Are organized or commercially domiciled in California
• Your California sales, property or payroll exceeds certain amounts.

With regard to exceeding certain sales amounts, it gets even muddier. There is a law that exempts certain companies outside of California from the tax even if they are making sales in California which is described by the Franchise Tax Board as follows:

Such broad explanations and definitions can make it extremely difficult for business owners to discern whether or not they must pay this tax. As well, there are ongoing battles in court in order to try to stifle the Franchise Tax Board’s broad interpretations. So even before the Coronavirus, these taxes have had the effect of discouraging business in the state.

But for now, everyone can go ahead and take a deep breath (albeit temporarily) when they form an LLC in California. California is changing its taxation policy to waive the $800.00 mandatory franchise tax for the first year on all new entities. LLCs, limited partnerships and limited liability partnerships that register in the years 2021, 2022 and 2023 will not have to pay the $800.00 in their first year of business. Through this change the state would be reducing the General Fund Revenue for California by about $50 Million dollars in 2020-21 and $100 Million dollars in 2021-22 and out years. The goal of the new legislation is “to help and reduce costs for first year California small business.” The legislation further notes that “…these taxes may stifle economic growth and job creation and may inhibit the formation of many small businesses.”  Which ironically, may have some new business owners holding off to open a new entity to avoid paying the 2020 franchise tax, thereby stalling the California economy even more until 2021 when the tax exemption will be placed. California traditionally has about 250,000 LLCs, partnerships and sole proprietorships formed each year. Now, to try and keep economic growth from stalling, the $800.00 fee is temporarily waived on the first year for these entities along with corporations. (Hopefully without the cumbersome tax filing requirements.) The cost of doing any sort of business in California is very high. Waiving the $800.00 fee for an LLC’s first year is a good start. But why not make the waiver permanent? Corporations are excluded from the fee for the first year, and have been for years. Allowing LLC’s and other entities a similar permanent first year exemption would be wise policy.