The California LLC – Taxes Until Death?

The limited liability company, better known as an “LLC”, has been marketed as the best individual business entity for most small businesses. The question, of course, is whether marketing reflects reality or not. In California, the situation is a bit murky, to say the least.

California is known for being as hostile to business as any other state. If they don’t tax you here, they pay you a strange rate over there. The weather makes up for it, but sometimes you really have to ask yourself if it’s all worth it. This is particularly true for small businesses that form limited liability companies only to be hit over the head with a series of surprises.

The first surprise is one that you could only find in California. The LLC is charged an annual fee of $800 for the “privilege of doing business in California.” O Joy. The fee is not due at the end of your first year, but within a few months of forming your business. Yes, the door is barely open and you are already being hit with state spending!

The next surprise comes when you start generating some business. The wicked surprise is known as the “gross receipts tax.” In addition to the $800 annual fee mentioned above, you must pay a tax based on your gross income. The tax doesn’t start until you make at least $250,000 a year, but it’s important to remember what we’re talking about here. This is a tax on “gross” income. An example will help explain what this means.

Imagine that I have a store that sells a high-priced item. My business plan calls for me to lose money for the first three years as the business develops. The first year I make $125,000 and lose $10,000 as expected. Then comes the second year. I bring in $260,000 in receipts and lose another $10,000. To my surprise, I have an additional $900 in gross income taxes. Yes, this is true even though I made no profit!

So should you avoid forming a California LLC? No, not really. It’s still a great choice. A corporation in California has to pay the same $800 fee, but not the gross receipts tax. As long as you know what you are getting into, the LLC is still worth the financial aggravation.