Opening a small business in California is an exciting opportunity for any owner. It’s a wonderful chance to run your own company and launch a business that you believe in.
When you’re thinking about opening a business in California, it’s important to understand the tax laws that affect your company. While there are many different tax laws that may apply, this guide shows you the key terms, levies and rates that you will pay.
There are a lot of advantages to running a business in California, which is the largest state economy in the United States. It is home to a highly educated workforce and has some of the nation’s largest cities, including Los Angeles, San Francisco and San Diego.
California residents are relatively wealthy compared to those in other states. Winters are not very cold and summers are not too hot in most areas of the state, with minimal humidity.
There are, however, some challenges to running a business in California. The cost of living can be high and traffic and congestion are an issue near major metropolitan areas. The costs of real estate are also high throughout the state.
In addition, small businesses face several high state tax rates and many business regulations.
Here’s a closer look at the California tax laws that apply to your small business.
Establishing a Business Structure
Each small business is required to establish a legal business structure, which governs how your company is taxed, your liability as an owner and how the business is operated. There are many different business types. Here is a brief look at each of the most common and their impact on your tax obligations.
Sole Proprietorship
The simplest business structure, a sole proprietorship involves no formal or legal paperwork to establish. The sole owner is responsible for all operations. From a tax standpoint, the sole proprietorship is considered a “pass through entity” because profits, losses and deductions are passed through to the owner’s individual federal and state tax returns.
Partnership
A partnership involves two or more owners. The obligations and responsibilities of the partners hinge largely on the type of partnership the company uses. The most common types are:
- General Partnership. The most basic, this partnership involves two or more partners who share responsibility and liability for the business
- Limited Partnership. In this structure, there is a general partner responsible for the operations and assumes most of the financial risk. Limited partners are investors in the business but are not involved in the day-to-day operations of the company
- Limited Liability Partnership. All partners can be involved in running the business but do not assume significant liability for the wrongdoings of other partners
Partnerships are also pass-through entities. A partnership agreement details the ownership stakes and obligations of each partner, who reflects their portion of the revenues and losses on their individual returns.
Corporations
Corporations are separate legal entities apart from their owners. Corporations have more formality and structure than other business types, and must file public disclosures about their financials, have a board of directors and hold annual meetings. They may also sell ownership stakes in the form of stocks.
There are two common types:
- C-Corporation. The most common corporate business type, a C-corporation is the costliest from a tax perspective, subject to double taxation. Ther corporation pays taxes on its corporate profits and owners have their dividends taxed on their individual tax returns
- S-Corporation. Shareholders are limited to 100. Unlike the C-corporation, an S-corporation has a pass-through tax structure
Limited Liability Company (LLC)
The LLC is the most popular business structure for small businesses. It protects owners from having liability for adverse court judgements.
The LLC’s profits and losses are passed through to the owner’s individual tax returns. However, an LLC owner can choose how to have their taxes calculated, either as a partnership or as a corporation.
Taxation and Your Small Business
California business owners must pay several types of state taxes in addition to any federal tax obligations.
Here are the main state taxes California small businesses face.
Corporate Tax
If your business is structured as a C-corporation or an LLC that opts to be taxed as a C-corporation, you will pay an 8.84 percent corporate tax rate on any net taxable income.
Alternative Minimum Tax
If your business is a C-corporation and has no taxable income, you must recalculate income without some credits or deductions. That new income figure is taxed at a flat rate of 6.65 percent .
Sales Tax
Retailers must obtain a seller’s permit from the state Department of Tax and Fee Administration. The statewide sales tax is 7.25 percent, though local municipalities usually add their own sales tax of 0.1 percent to 1 percent.
Sales tax is levied on all tangible goods and services that are related to the creation of tangible goods.
Employment Taxes
Employers should register with the California Employment Development Department.
Employers must pay for employment-related taxes, including the unemployment tax and employee training tax (3.4 percent and 0.1 percent, respectively, on the first $7,000 of wages), state disability insurance of 0.9 percent of wages and personal income tax, which varies.
These taxes are paid quarterly.
Franchise Tax
LLCs, some limited partnerships and some corporations are required to pay a franchise tax.
Limited partnerships, limited liability partnerships and LLCs with gross revenue less than $250,000 pay a flat rate of $800.
LLCs with gross revenue exceeding $250,000 pay a revenue-based fee up to a maximum of $11,790.
S-corporations pay a rate of 1.5 percent on net income and a minimum of $800. C-corporations with no taxable income must pay the $800 franchise fee and the alternative minimum tax.
LLC businesses that are registered, organized or filed between 2021 and January 1, 2024, do not have to pay the $800 for their first year in business.
Income Taxes in California
No matter what filing status a small-business owner uses, they will pay state income tax on their income. The tax rates are progressive, meaning that residents pay a higher rate on various bands of income.
For example, a taxpayer filing as married filing jointly will pay the following rates:
- $0 to $20,198 in taxable income (1 percent)
- $20,199 to $47,884 (2 percent)
- $47,885 to $75,576 (4 percent)
- $75,577 to $104,914 (6 percent)
- $104,915 to $132,590 (8 percent)
- $132,591 to $677,278 (9.3 percent)
At higher income levels, the rate rises to as high as 12.3 percent.
Tax Credits for California Small Businesses
If you’re a small-business owner looking to lower your tax obligation, the state of California offers several incentive programs designed to reduce tax bills. They include the following.
California Competes Tax Credit
This program provides more than $180 million in tax credits to businesses seeking to locate in California or stay and grow in the state. The competitive program is open to businesses of any size or industry and in any location.
Businesses are evaluated based on 14 criteria, including the number of full-time jobs generated, strategic relevance to the state or region, and the amount of investment owners are spending. In fiscal 2023-24, there are three application periods, the last of which is from March 4-18, 2024.
Candidate businesses submit a project proposal and have costs reimbursed if accepted.
Work Opportunity Tax Credit
This program provides support to businesses that hire employees who often face considerable barriers to employment. While this is a credit on federal taxes, it is administered by the state Employment Development Department and provides up to $9.600 in credits for each employee hired.
Target groups include veterans, ex-felons and young people. The state also offers the Fidelity Bonding Program, which offers bonding services to reduce concerns about hiring ex-felons and other at-risk employees, providing insurance against possible theft or fraudulent or dishonest acts.
California Opportunity Zones
The California Opportunity Zones program was launched in 2017 and is designed to encourage community development and investments in economically distressed areas. New investments in affordable housing, climate change, environmental justice and sustainability may be eligible for preferential tax status.
Investors in Opportunity Zones can defer federal tax payments on capital gains by reinvesting those proceeds in a Qualified Opportunity Fund. If investors hold those assets in the fund for at least 10 years, they will not need to pay any federal taxes on realized gains from the investment.
Tax Deductions for Small Businesses
California small businesses can further reduce their tax obligations by deducting certain expenses from their tax bills. Tax deductions are typically applied to the federal return and reduce your net income, which affects your state tax obligation.
Common tax deductions include home office, business travel and meals, marketing and advertising, education and training, office supplies and utilities.
Running a California small business is a wonderful opportunity to leverage the largest state economy in the nation. By understanding your state tax obligations, choosing the right business structure for your company, and leveraging credits and deductions, you can ensure that you plan accordingly and maximize your profits.