California Corporate Tax Rate: Everything You Need to Know
The California corporate tax rate has not yet provided small business owners with incentives for doing business in the state. 9 min read
2. Different Types of Business Taxes in California
3. Corporation Income Tax
4. What Kinds of Businesses Have to Pay the California Corporate Income Tax?
5. Double Taxation for Small Businesses
6. S Corporations
8. Partnerships and Sole Proprietorships
9. Federal Corporate Income Tax
10. Sales and Use Tax
11. Property Taxes
12. Unemployment Insurance
13. Disability Insurance
14. Workers' Compensation Insurance
15. California Nonprofit Tax Exemptions
16. Note on Multistate Businesses and “Nexus”
The California corporate tax rate has not yet provided small business owners with incentives for doing business in the state.
California Corporate Tax Rate
The California corporate tax rate has not yet provided small business owners with incentives for doing business in the state. However, California is known as the home to several diverse, vibrant and growing metropolitan cities, including Los Angeles, Oakland, and Sacramento. These metro areas are booming with talented individuals, many of whom are upper-class, prosperous residents, and are hosts to admired colleges and universities that continuously pump out young, educated adults.
California could be doing a much better job of attracting small business owners to the state. Corporate taxes in California are some of the highest of any other state in the U.S. High taxes, in conjunction with burdensome regulations, have caused many business owners to go out in search of a different state to incorporate in that will be friendlier to small businesses, such as Texas and Florida.
Different Types of Business Taxes in California
There are three types of income taxes in California that businesses should be aware of:
- Corporate tax
- Franchise tax
- Alternative minimum tax
Almost all businesses are required to pay at least one of these taxes, while many are subject to more than just one.
Corporations and LLCs are subject to the corporate tax. The corporate tax rate is around 9 percent (higher than average) and applies to a business's net taxable income. While corporations are not required to pay the franchise tax, they are required to pay the alternative minimum tax (AMT), which is usually around 6.5 percent and places a check on a business that is writing off expenses in order to lower the amount it pays for corporate taxes.
The franchise tax applies to S corporations, limited liability corporations, limited partnerships and limited liability partnerships. It prevents corporations from trying to minimize their corporate taxes by writing down their income. Those corporations that are not required to pay corporate tax (because they don't earn positive net incomes) are typically required to pay the franchise tax as an alternative. This tax rate is 6.65 percent and is based on federal guidelines.
Corporation Income Tax
California's corporate income tax is a form of business tax imposed on the gross taxable income of corporations and other businesses that are registered or conducting business in the state. It is the business equivalent of the personal income tax and calculated based on an income bracket system. Similar to individuals, businesses are required to file a yearly tax return and allowed to claim deductions such as cost of goods sold, wages paid, and other eligible business expenses.
In order to determine its corporate income tax, California looks at the portion of business' income that can be attributed to California and is thus subject to its Bank and Corporate Franchise Tax. The income derived from all of the business activity in the state is divvied up using an apportionment formula. The percentage of property, payroll, and sales attributed to California, as opposed to global operations, is calculated, added together and divided by four to determine the income subject to California's Bank and Corporation Franchise tax.
Global corporations are then able to make a “Water's Edge” election which allows them to exclude most of their income derived from global operations. Foreign businesses that have an apportionment percentage more than 20 percent must be included in a report. The Water's Edge election lasts for seven years but can be automatically renewed unless the business files a notice of non-renewal.
As of Jan. 1, 2011, businesses in California are given the option of selecting a Single Sales Factor. This option allows companies to weigh only their sales – not property or payroll income – made in California to determine the amount of corporate taxes they owe.
What Kinds of Businesses Have to Pay the California Corporate Income Tax?
Every company doing business in California must report their earned income and pay both California and federal corporate income taxes. Non-flow-through entities, such as a sole proprietorship, partnership, or S corporation, are not subject to these same requirements.
Traditional corporations, or C-Corporations, are the most common business structure subject to corporate taxes, which is 8.84 percent or 6.65 percent depending on whether they claim net taxable income. These types of corporations pay taxes on their revenue, in addition to the personal income of their shareholders and owners. This type of phenomenon is called double-taxation. If the business pays out that income with dividends, California imposes one of the highest marginal tax rate at 33 percent.
Double Taxation for Small Businesses
One of the reasons California has not historically been small-business friendly is because its state income taxes on both business and personal income are higher than average. It imposes both of these taxes on small business owners who set up their businesses as S corporations or limited liability companies (LLCs), among others. These types of businesses typically avoid federal income tax because their earned income passes through to the business owners. California taxes both the business owner and the business itself, which the federal government considers double taxation.
While a majority of the states have some sort of double taxation, California is unique in that it hits business owners from both sides. Combine this with the fact that California also has an enormous high cost of living, the state's tax treatment on small businesses makes it extremely difficult and unlikely that an entrepreneur is able to get his start-up off the ground.
An S corporation enjoys the same financial and legal protections as a C corporation, as well as pass-through taxation. It is only subject to a franchise tax of 1.5 percent on its net income. Even if an S corporation claims zero or negative income, it must pay a minimum franchise tax of $800. An S corporation that has a net income of $1 million must pay 1.5 percent of it, or $15,000 to the state of California.
Unlike a C corporation, an S corporation does not have to pay separate federal income tax. Its taxable income is passed through to its shareholders, who are subject to federal tax on their shares of that income. The tax rates for shareholders vary depending on their individual net incomes for a certain year.
California is different from other states in that it does not treat an S corporation as a pass-through entity for state tax purposes, although it recognizes the federal S election.
An LLC is also required to pay a franchise tax, but pays a flat dollar amount based on gross incomes tiers, as opposed to a flat percentage based on net income. The dollar amounts to be paid for different gross income tiers are as follows:
- $800 (minimum franchise tax) for gross incomes of less than $250,000
- $900 for gross incomes of $250,000 to $499,999
- $2,500 for gross incomes of $500,000 to $999,999
- $6,000 for gross incomes of $1 million to $4,999,999
- $11,790 for gross incomes of $5 million and above
In addition, an LLC's net income is passed through to its business owners, and they must also pay a personal income tax at a rate of anywhere between 1 to 12.3 percent. A default LLC is regarded as a partnership for tax purposes. However, it is possible for an LLC to elect corporation status. If that is the case, the LLC will be required to pay corporate income tax and the alternative minimum tax.
Partnerships and Sole Proprietorships
California treats partnerships differently depending on the specific type. For example, a limited liability partnership or limited partnership must pay a franchise tax of $800 at a minimum, and the business owners must also pay personal income tax on any income that runs through the business. For general partnerships, only the personal income tax applies because the partnership's income is allocated directly to the partners.
For instance, if a partnership earns a net income of $100,000, the amount will be divided among the partners, who will pay taxes on their portions on their personal tax returns. The personal income tax rate for each partner varies depending on his or her total net income for the year.
If you are a sole proprietor, you will receive all the income from your business and pay state tax on that income.
Federal Corporate Income Tax
Similar to personal income tax, federal corporate tax is bracketed according to income levels. There are altogether eight federal corporate tax brackets. The following tax rates have been applicable from 1994 to 2017:
- 15 percent for an income bracket ranging from $0 to $50,000
- $7,500 plus 25 percent of the amount over $50,000 for incomes ranging from $50,000 to $75,000
- $13,750 plus 34 percent of the amount over $75,000 for incomes ranging from $75,000 to $100,000
- $22,250 plus 39 percent of the amount over $100,000 for incomes ranging from $100,000 to $335,000
- $113,900 plus 34 percent of the amount over $335,000 for incomes ranging from $335,000 to $10,000,000
- $3,400,000 plus 35 percent of the amount over $10,000,000 for incomes ranging from $10,000,000 to $15,000,000
- $5,150,000 plus 38 percent of the amount over $15,000,000 for incomes ranging from $15,000,000 to $18,333,333
- $6,416,667 plus 35 percent of the amount over $18,333,333 for incomes ranging from $18,333,333 to the marginal corporate income tax rate
Sales and Use Tax
California imposes a sales and use tax of 7.25 percent. Localities and cities can elect to add a percentage onto the state tax, which is currently averaging about 1 percent. The sales tax applies to retailers' receipts from the sale of any tangible personal property and is imposed directly when a consumer purchases the item.
A use tax is applied on items that are purchased with the purpose of using them in California. It is self-reported and paid based upon the jurisdiction's applicable rate.
Every county government in California administers the state's property taxes. Property tax is based on 100 percent of what the property is valued at. The State Board of Equalization oversees the county assessor's' valuation. The average property tax rate in California is 1.1 percent, but this will vary based on each property.
When real property, or land, goes through a change in ownership or installs some new construction, it must be appraised. It is then adjusted on a yearly basis at the rate of inflation as measured by the Consumer Price Index. If the value of real property is higher than the current market value, the property can be reduced.
The personal property of a business is taxed at the same rate as real property. However, personal property must be reappraised annually. Business owners are required to file a property statement which states the market value of the property. This must be filed with the county assessor each year.
Every employer must pay a certain amount to the Unemployment Insurance Fund, which pays for unemployment benefits. The employer is typically required to pay 3.4 percent on the first $7,000 in wages.
Regulated by the California Employment Development Department, disability insurance is a form of tax paid by employees. The maximum amount of disability insurance per employee is $434, which is calculated at the highest unemployment insurance tax rate of 6.2 percent of $7,000. In 2011, the State Disability Insurance withholding rate was 1.2 percent. The limit for taxable wage for each employee per year is $93,316, and the maximum withholding amount per employee is $1,026.48.
Workers' Compensation Insurance
The workers' compensation system in California is administered by the Department of Insurance and the Department of Industrial Relations. In 2005, an important reform legislation known as SB 899 was enacted to overhaul the state's workers' compensation system. It imposed a number of new requirements, including independent medical reviews, employer-selected physician networks, and uniform standards. The Department of Insurance reported that base rates have gone down more than 35 percent since January 2004.
California Nonprofit Tax Exemptions
Certified nonprofit organizations, such as 501(c) organizations registered in California, may qualify for state and federal corporate tax exemptions on some or all of their income. In order to qualify for a 501(c) status, and thus a tax-exempt status, a business must obtain a nonprofit Tax-Exempt ID number from the IRS. The state can also require nonprofits to file additional paperwork in order to gain exemption status. Nonprofit organizations that are commonly exempted from corporate income tax in California include:
- Worker's organizations and labor unions.
- Nonprofit educational and scientific groups, such as nonprofits schools, colleges, and some research institutions.
- Churches, synagogues, mosques, and other bona fide religious institutions.
- Bona-fide charitable organizations, both religious and non-religious.
- Recreational groups and social clubs are allowed to collect dues and other types of funds as tax-exempt organizations, as long as their main purpose is not for profit.
Note on Multistate Businesses and “Nexus”
If a business is operating in more than one state, the owners should be aware that the business could be considered to have a “nexus” and may be required to pay taxes in those states. It also works the other way around. If a business incorporated itself in a different state but does business in California, it may be required to pay taxes in California.
Defining what a “nexus” is can be difficult and complication. It is thus recommended that if an owner runs a business that operates in multiple states, he should consult with a tax professional.
If you need help with getting your business set up in California, you can post your legal need on UpCounsel's marketplace.