Many entrepreneurs in California are surprised to learn that if you form an entity here, you’re most likely on the hook for a mandatory minimum $800.00 annual tax called the Franchise Tax. It’s really a tax for the privilege of existing or doing business in this state and it can be problematic for some startups for which an $800.00 mandatory payment in their first tax season can be substantial.
Can an entity avoid paying the tax? Yes, but in only two narrow circumstances: (1) the entity has been granted non-profit status by the IRS and the Franchise Tax Board; or (2) the entity was formed fewer than 14 days before the end of its fiscal year AND it does no business during those days. (Typically, small businesses elect December 31 as the end of the fiscal year, so that means that the entity would need to be formed after December 17 to receive the exemption. If your entity has selected a different fiscal year, then your cutoff date will correspond to whatever fiscal year end it’s selected.) Note that exemption (B) only applies to the tax year in which the entity was formed.
Satisfy either of (A) or (B) and you’re free of the tax. Fall outside of either parameter, and you’d best set aside at least $800.00 each year to fund your payment at tax time.
Greg Borman is an attorney in San Diego, California, who advises and represents businesses of all sizes and stages, as well as their owners. He can be reached at firstname.lastname@example.org or at (858) 232-7100.