California Franchise Tax
What is the CA Franchise Tax?
If you are a startup that has employees, rent, or revenue in CA… and you’ve registered to do business in CA then you will need to pay CA Franchise Tax. These taxes have nothing to do with your revenue, income, profitability, or even if you have an office or presence in that state. Also, this is separate from the “tax return” which is known as the 1120. It’s a tax for the privilege of being a business in California, and startups (which should be C-Corps) are no exception.
Who pays the California Franchise Tax?
The California Franchise Tax applies to various business entity types, including:
- C corporations
- S corporations
- Limited Liability Companies (LLCs)
- Limited Partnerships (LPs)
- Limited Liability Partnerships (LLPs)
It’s important to note that sole proprietorships, general partnerships, and tax-exempt organizations are generally not required to pay this tax.
California Franchise Tax rates and minimum payment
The California Franchise Tax rates depend on your business’s tax classification:
- C corporations: 8.84% of net income or $800, whichever is greater
- S corporations: 1.5% of net income or $800, whichever is greater
- LLCs, LPs, and LLPs: $800 minimum
For most startups, especially those operating at a loss, the minimum payment of $800 will apply. However, if you’re a profitable C corporation, you may need to pay more. For example, if your C corporation makes $15,000 in net income, you would owe $1,326 (8.84% of $15,000). Remember to work with a CPA; this information is for informational purposes only!
When is the California Franchise Tax due?
The due date for the California Franchise Tax varies depending on your business entity type:
- C corporations: April 15th (the 15th day of the 4th month after your tax year ends)
- S corporations: March 15th (the 15th day of the 3rd month after your tax year ends)
- LLCs: April 15th (the 15th day of the 4th month from your formation date)
It’s crucial to mark these dates on your calendar, as you won’t receive reminders from the state. If you’re based in San Francisco, you might find ourSan Francisco Startup Tax Compliance Calendar helpful for keeping track of various local tax deadlines, or visit our other tax deadline calendars for startups.
How to pay the California Franchise Tax
You can pay the California Franchise Tax online, by mail, or in person at the California Franchise Tax Board Field Offices. Here’s a step-by-step guide for online payment:
- Visit theCA FTB Webpay site
- Select “Pay Today” (don’t register)
- Enter your company ID, which you can look up by name on theSecretary of State website
- Select form 100
- Choose “Estimates Payment”
- Enter $800 (or the appropriate amount based on your net income)
- Enter the tax year (e.g., 1/1/2024-12/31/2024)
Important California franchise tax considerations for startups
Delaware C-Corps doing business in California
If you’re a Delaware C-Corp with employees, rent, or revenue in California, and you’ve registered to do business in the state, you’ll likely need to pay the California Franchise Tax. This is in addition to any franchise tax you may owe to Delaware. California does have quite a few different tax obligations for startups, so pay attention, work with a great lawyer and tax firm (like us!).
California Franchise Tax first year exemption for corporations
Newly incorporated corporations are not required to pay the minimum franchise tax in their first year of operation. However, this exemption doesn’t apply to other entity types like LLCs.
Avoiding back-to-back payments
The California Franchise Tax is not prorated, which means even if you form your business late in the year, you’ll owe the full $800 for that year. To avoid back-to-back payments, consider:
- Delaying formation until January of the following year
- Including a “future file date” on your articles of incorporation when you file (talk to your lawyer about this)
Tax planning strategies
To optimize your tax planning:
- Consult with a startup-focused CPA to ensure you’re paying the correct amount
- Consider the timing of your business formation to minimize initial tax burdens - talk with your lawyer
- Stay informed about any changes in California business regulations that may affect your tax obligations
Don’t forget to file yourCalifornia Statement of Information, an annual filing requirement for corporations and LLCs doing business in California. This is separate from your franchise tax obligation but equally important for maintaining good standing with the state.
Consequences of franchise tax non-payment for VC-backed startups
Failing to pay your California Franchise Tax can have severe repercussions for your startup, especially if you’re VC-backed or planning to raise funds. Here’s what could happen:
Impact on fundraising
- Loss of good standing: When your franchise tax lapses, your company loses its “good standing” status with the California Secretary of State. This status is crucial for fundraising, as investors and their legal counsel usually check this during due diligence. At least the good ones do, and it’s unlikely that anyone doing a Series A or B won’t check this.
- Derailed funding rounds: A lapsed franchise tax can delay or even derail ongoing funding rounds. VCs may view this as a red flag, indicating poor financial management or lack of attention to crucial compliance matters. We can’t tell you how many times a prospective client has come to us in a frenzy because they got a term sheet, and the VC then came and let them know that their status has lapsed. This will slow down your fundraise (see the insurance problems and director liability bullets below).
- Increased investor scrutiny: Even if you resolve the issue quickly, it may lead to increased scrutiny from potential investors, potentially complicating your fundraising efforts. Because it makes you look junior varsity, the VC is likely to put more time and effort into making sure your other compliance and legal paperwork has been done correctly.
Operational challenges
- Payroll issues: Your company may lose its ability to process payroll legally. This could result in missed or delayed payments to employees, potentially leading to staff turnover and legal issues. This is a serious issue.
- Banking problems: Banks may freeze your company’s accounts or refuse to process transactions if your business is not in good standing with the state, or at a minimum it will be close to impossible to open new accounts.
- Insurance complications: Your business insurance policies may become invalid, leaving your company exposed to various risks without coverage. Note that your insurance company may or may not notify you about this. And keep in mind that VCs always want their portfolio companies to have D&O insurance; it’s usually baked into the investment legal paperwork.
- Contract voidability: Contracts entered into while your company is suspended may be voidable at the discretion of the other parties, putting your business relationships at risk.
Legal and financial ramifications
- Penalties and interest: The California Franchise Tax Board will impose penalties and interest on the unpaid tax, increasing your financial burden.
- Personal liability: Directors and officers may become personally liable for some of the company’s debts incurred during the period of suspension. VCs hate personal liability, so don’t let this happen.
- Loss of legal rights: Your company may lose the right to use its name in California, and it cannot bring a lawsuit or defend itself in court while suspended.
- Compliance cascade: Failure to pay franchise tax often leads to other compliance issues, such as inability to file annual reports or maintain required business licenses.
Recovery process
Recovering from a franchise tax lapse can be time-consuming and costly:
- Revivor process: You’ll need to go through a “revivor” process to reinstate your company, which involves paying all back taxes, penalties, and interest.
- Professional fees: You may need to hire legal and accounting professionals to help navigate the reinstatement process and address any resulting complications. While we, as CPAs who know California rules really well, get paid to do this… it’s not really the kind of work we want to do - so don’t let it happen to you.
- Reputation damage: You are just going to look like you don’t know what you are doing to your VCs. You don’t want them questioning your chops.
For VC-backed startups, maintaining compliance with franchise tax obligations is crucial. The potential disruption to your fundraising efforts and operations far outweighs the cost of the tax itself. Always prioritize your franchise tax payments and consider setting up automatic reminders or working with a startup-focused accountant to ensure you never miss this critical obligation.
Additional tax considerations for California startups
While focusing on the California Franchise Tax, it’s important to be aware of other tax obligations that may affect your startup. For instance, some startups may be eligible for aCalifornia Partial Sales Tax Exemption on certain purchases, which can help reduce overall tax burdens. Make sure to explore all available exemptions and credits to optimize your startup’s tax strategy.
Articles of Organization and California Franchise Tax
When forming your business in California, you’ll need to file Articles of Organization (for LLCs) or Articles of Incorporation (for corporations). These documents are essential for various business activities, including:
- Opening a bank account
- Undergoing VC due diligence
- Establishing your company’s legal existence in the state
It’s important to note that the filing of these documents often triggers your obligation to pay the California Franchise Tax. Here are some key points to remember:
- The terminology can vary by state. In California, you’ll typically hear “Articles of Organization” for LLCs and “Articles of Incorporation” for corporations.
- The date on your Articles of Organization or Incorporation is crucial for determining when your California Franchise Tax obligation begins.
- For corporations, remember that you’re exempt from the minimum franchise tax for your first year. However, this exemption doesn’t apply to LLCs.
- When filing your Articles, consider including a “future file date” if you’re forming your business late in the year. This can help you avoid paying the franchise tax for a short initial tax year. Remember to always work with a lawyer who knows startups!
- Keep your Articles of Organization or Incorporation safe, as you may need them for future tax filings or business transactions. Here is how to find your articles of incorporation on various state’s websites.
Conclusion
Understanding and complying with the California Franchise Tax is essential for any startup doing business in the state. By staying informed about your tax obligations, planning strategically, and seeking professional advice when needed, you can ensure your business remains in good standing with the state while minimizing unnecessary tax burdens.
Remember, while this guide provides a comprehensive overview, tax laws and regulations can change. Always consult with a qualified CPA or tax professional for advice tailored to your specific situation.
