California Startup Taxes
The taxes that you’ll need to pay depend on your unique situation, so it’s best to contact a CPA.
I’m a CPA and the founder of the largest CPA firm 100% dedicated to VC-backed startups; my team works with 800+ startups - most of which have tax obligations in California.
– Vanessa Kruze, CPA and CEO
This comprehensive guide will walk you through the essential aspects of California startup taxes, with a focus on Delaware C-Corps and high-growth tech companies.
Founder & CEO, Kruze Consulting
Understanding California startup taxes for VC-backed companies
California is a great place to found a VC-backed startup, for obvious reasons - but the state’s tax system can be complex and burdensome for new businesses. As a VC-backed startup, it’s crucial to understand your tax obligations to ensure compliance and optimize your tax strategy. If you are successful, someone (an investor or acquirer) is eventually going to do legit due diligence - and that will include tax diligence. So you need to get this stuff right.
Key tax deadlines for California startups
Startups face numerous tax deadlines throughout the year. Here are some key dates to keep in mind:
- January 31: Send out 1099s to contractors and W2s to employees
- March 15: C Corp Tax Return due (can be extended to September 15 for Federal)
- April 15: $800 Annual California Franchise Tax due
- April 15: CA Form 100, the annual income tax return for businesses, is due
- April 15: First quarter estimated tax payment due
- June 15: Second quarter estimated tax payment due
- September 15: Third quarter estimated tax payment due
- January 15 (following year): Fourth quarter estimated tax payment due
These are just a few of the important deadlines. To help you stay on top of all your tax obligations, we’ve created comprehensive tax deadline calendars for many major startup locations in California:
- San Francisco Startup Tax Compliance Calendar
- San Jose Startup Tax Compliance Calendar
- Palo Alto Startup Tax Compliance Calendar
- Santa Monica Startup Tax Compliance Calendar
- Mountain View Tax Deadlines Calendar
These calendars provide detailed overviews of city-specific deadlines and can be invaluable tools for managing your tax compliance.
Who has to file taxes in California? Understanding tax nexus
Many founders I talk to don’t understand the concept of tax nexus - the compliance concept that determines if your startup is obligated to file taxes in California (or any particular location).
What is tax nexus?
Tax nexus describes the relationship between a taxing authority and a business. Tax nexus must exist before a state’s taxing authority can levy a tax on a business and require a business to make particular tax filings, etc.
Your startup likely has tax nexus in California if:
- You’ve registered to do business in the state
- You have employees working in California
- You maintain an office or own/rent property in the state
- You have inventory or other assets in California
- You generate significant sales revenue from California customers
If any of these conditions apply to your startup, you’ll likely need to comply with California’s tax laws, regardless of where your company is incorporated. This includes filing the appropriate tax returns and paying any taxes due to the state. And this is yet another reason that it’s important to work with a CPA who understands California startup taxes.
Key California taxes for startups
- Corporate Income Tax
- California Franchise Tax
- Alternative Minimum Tax (AMT)
- Sales and Use Tax
- Payroll Taxes
- Property Taxes
- Local Business Taxes
California Franchise Tax Board (FTB) and startup tax compliance
The California Franchise Tax Board (FTB) is the state agency responsible for administering California’s income tax laws.
For startups, maintaining compliance with FTB regulations is essential. Here are some key points to remember:
- Franchise Tax: Most businesses, including startups, must pay at least the minimum franchise tax of $800 annually.
- Corporate Income Tax: C corporations pay a flat rate of 8.84% on their net income from California sources.
- Alternative Minimum Tax (AMT): Corporations may be subject to a 6.65% AMT if their regular tax liability is lower than the AMT.
E-filing and MyFTB account
To simplify tax filing and payments, the FTB offers an e-filing system called CalFile. Creating a MyFTB account allows you to manage your business taxes efficiently, including making payments and checking your account status.
We do love the music in the background of the FTB’s video about the MyFTB portal! Although the people’s comments on Youtube about it are pretty rough.
Tax considerations for Delaware C-Corps operating in California
Many VC-backed startups incorporate in Delaware but operate in California. This structure comes with specific tax implications:
- Foreign Qualification: You must register your Delaware C-Corp as a foreign entity doing business in California.
- Nexus in California: Your company will likely have nexus in California, subjecting you to California taxes.
- Double Taxation: Be aware of potential double taxation on corporate income and shareholder dividends, although since most startups don’t generate income and pay dividends, this isn’t an issue for most of our clients.
California corporate tax rate and startup-specific considerations
The California corporate tax rate is 8.84% for C corporations. However, startups should be aware of several other tax-related factors:
- Net Operating Losses (NOLs): California allows NOLs to be carried forward, which can be beneficial for startups operating at a loss in early years. However, it’s important to note thatCalifornia has partially suspended the use of NOLs for tax years 2020-2023. This change can significantly impact startup tax planning.
- R&D Tax Credits: California offers a state-level R&D tax credit, which can be valuable for tech startups. Note that it’s not as useful as the federal research and development tax credit, which we prepare a lot of.
- California Partial Sales Tax Exemption: Some startups may qualify for partial sales tax exemptions on certain purchases.
What is the tax filing deadline in California?
The tax filing deadline in California is April 15, 2024. However, California taxpayers get an automatic extension to file until October 15 this year.
It’s important to note that any taxes owed must be deposited or postmarked by April 15, 2024. If you’re unsure whether you’ll owe money, you can use the FTB’s Tax Calculator for an estimate. Again, reference our tax deadline calendars (links above) to see more city-specific filing deadlines.
Tax planning for startups in California
Effective tax planning is crucial for startups to minimize their tax burden and maximize available benefits. Consider the following strategies:
- Equity Compensation: Understand the tax implications of stock options and other equity-based compensation for both the company and employees.
- Startup Bookkeeping: Maintain accurate financial records to support tax filings and potential audits.
- Quarterly State Tax Payments: Plan for estimated tax payments to avoid penalties.
- Business Expense Deductions: Track and categorize all eligible business expenses for potential deductions.
California tax incentives for startups
California offers several tax incentives that can benefit startups:
- California Competes Tax Credit: A negotiated tax credit available to businesses that want to relocate, stay, or grow in California.
- New Employment Credit: Available for businesses that hire qualified employees in designated geographic areas.
- Research and Development Tax Credit: A valuable credit for startups engaged in qualified research activities.
- California Sales Tax Exemption: To qualify for the exemption, companies must be classified as “qualified persons,” which generally includes businesses primarily engaged in manufacturing, R&D, etc.. These classifications are determined by specific NAICS codes.
Payroll taxes for startups in California
Managing payroll taxes is a crucial aspect of startup tax compliance. Key considerations include:
- State Unemployment Insurance (SUI)
- Employment Training Tax (ETT)
- State Disability Insurance (SDI)
- Personal Income Tax (PIT) withholding
Ensure proper classification of employees vs. contractors to avoid potential tax issues. We always strongly recommend using an automated payroll provider; you can learn about the best payroll providers for startups here.
Sales tax considerations for California startups
Understanding and managing sales tax obligations is crucial for startups operating in California.
The state’s complex tax laws can be particularly challenging for Software as a Service (SaaS) companies and other tech startups. Let’s break down the key aspects of sales tax for California startups.
General sales tax rules in California
California imposes a sales tax on retail sales of tangible personal property in the state. The statewide base sales and use tax rate is 7.25%, but total rates can be higher in certain cities and counties due to district taxes.
Key points for startups to remember:
- Nexus: You may have sales tax nexus in California if you have a physical presence (office, employees, inventory) or meet certain economic thresholds.
- Economic nexus: As of April 1, 2019, out-of-state sellers with more than $500,000 in annual sales to California customers must collect and remit sales tax.
- Marketplace facilitators: If you sell through online marketplaces, the facilitator may be responsible for collecting and remitting sales tax on your behalf.
Sales tax for SaaS companies in California
Software as a Service (SaaS) companies face unique sales tax challenges in California. As a leader in SaaS accounting, we think a lot about this! Here’s what you need to know:
- Generally non-taxable: In California, SaaS is generally considered a service and is not subject to sales tax. This is because the software is accessed remotely and no tangible personal property is transferred to the customer.
- Exceptions: While pure SaaS is typically not taxable, there are exceptions:
- If any tangible personal property (e.g., hardware, physical media) is transferred as part of the service, that portion may be taxable.
- If the SaaS includes a right to download software onto the customer’s computer, it may be considered taxable.
- Hybrid products: Some SaaS offerings may include both taxable and non-taxable components. In these cases, you may need to determine the taxable portion of your sales.
- Custom software: If your SaaS includes custom software development, this may be treated differently for tax purposes.
- Training and support: Any separate charges for training or support services are generally not taxable in California.
So it’s obviously not cut and dried in every situation - that’s why we have a sales tax team! Work with a qualified CPA firm.
Challenges for SaaS startups in California
Despite the general non-taxability of SaaS in California, startups in this space still face several challenges:
- Determining taxability: The line between taxable and non-taxable can be blurry. You may need to closely examine your offering to determine if any components are taxable.
- Multi-state sales: If you sell to customers in other states, you’ll need to be aware of their specific SaaS taxability rules, which may differ from California’s.
- Changing laws: Tax laws are constantly evolving, especially in the tech space. Stay informed about any changes that could affect your tax obligations.
- Record-keeping: Maintain detailed records of your sales, including the nature of what was sold and the customer’s location, to support your tax positions.
Best practices for managing sales tax
To stay compliant with California’s sales tax laws, consider these best practices:
- Conduct a nexus study: Determine where you have sales tax obligations, both in California and other states.
- Implement proper systems: Use accounting software that can track sales by location and product type.
- Stay informed: Keep up with changes in tax laws that could affect your business.
- Collect customer information: Always collect and maintain accurate customer address information for all sales.
- Consider automation: Tools like Avalara can help automate sales tax calculations and filings.
- Regular reviews: Periodically review your products and services to ensure you’re treating them correctly for sales tax purposes.
- Seek professional help: Consult with a qualified CPA or tax attorney who specializes in California sales tax and SaaS companies.
The importance of compliance
While managing sales tax can be complex, it’s crucial for startups to get it right. Failure to comply with sales tax laws can result in:
- Audits and penalties
- Accrued interest on unpaid taxes
- Potential personal liability for business owners
- Complications during due diligence for funding rounds or M&A activities
By understanding your sales tax obligations and implementing proper practices from the start, you can avoid these pitfalls and focus on growing your business.
Remember, while this guide provides a general overview, sales tax laws are complex and constantly changing. Always consult with a qualified tax professional to ensure you’re meeting all your obligations specific to your business model and circumstances.
Venture debt tax implications
For startups considering venture debt, be aware of the tax implications:
- Interest Deductibility: Interest payments on venture debt are generally tax-deductible.
- Warrant Valuation: The value of any warrants issued with the debt may have tax consequences.
M&A tax considerations for startups
As your startup grows, you may consider mergers and acquisitions. Be aware of the following tax considerations:
- Stock vs. Asset Sales: Different tax implications for buyers and sellers.
- Tax-Free Reorganizations: Certain transactions may qualify for tax-free treatment.
- California’s Treatment of Goodwill: California has specific rules regarding the taxation of goodwill in M&A transactions.
Staying compliant with California business regulations
Beyond taxes, startups must comply with various California business regulations, including but not limited to:
- California Statement of Information: File this annual report to maintain good standing with the state.
- Local Business Licenses: Many cities and counties require additional licenses or permits.
- Employment Laws: California has strict employment regulations that startups must follow.
How do I minimize my taxes when selling my startup in California?
Unfortunately, there’s no straight answer to this. It will depend on where the acquirer is located, what industry you are in, the details of you own personal tax situation, and a myriad of other factors. You’ll want to consult with a CPA that specializes in startup taxation, as any advisory services will be tailored to your unique situation. The guidance will pay for itself many times over and is worth the investment.
Qualified Small Business Stock (QSBS) Exemption - A Federal Tax Break that California Startups Should Consider
One key tax benefit to consider when selling your California startup is the Qualified Small Business Stock (QSBS) exemption. This is a federal provision, not a California state one, and it’s outlined in Section 1202 of the Internal Revenue Code. It allows founders and early investors to potentially exclude up to $10 million or 10 times their original investment (whichever is greater) from federal capital gains taxes when selling their shares. That’s potentially a lot!
To qualify for the QSBS exemption, your startup must meet several criteria, including:
- Being a C-corporation
- Having gross assets of $50 million or less at the time of and immediately after stock issuance
- Using at least 80% of its assets in an active, qualified trade or business
- Holding the stock for at least five years before selling
- Several other minor provisions - that are easy to trip up and fail!
If your startup - and the shareholders - meets these requirements, the QSBS exemption can significantly reduce your tax burden when selling your company. It’s essential to work with a CPA who thoroughly understands the QSBS rules to ensure you’re maximizing this valuable tax benefit.
Does California Have a QSBS Provision?
While the federal QSBS rules under Section 1202 of the Internal Revenue Code allow for significant tax exclusions on gains from the sale of QSBS, California has its own set of rules and does not conform to the federal guidelines. In 2012, the California Court of Appeal ruled that certain provisions of the California QSBS statute were unconstitutional, leading the California Franchise Tax Board (FTB) to declare the entire statute invalid and unenforceable for tax years beginning on or after January 1, 2008. Consequently, California repealed its QSBS tax exclusion provisions in 2013, and all capital gains, including those from QSBS, are now taxed at the same rate as ordinary income in California. This means that gains from the sale of QSBS are subject to California’s high state income tax rates, which can go up to 13.3%.
So, basically, California startups may be able to minimize or reduce federal capital gains at an exit, but the state is still going to expect to get paid.
Feel free to reach out to me (Kruze Consulting) if you need any help: I’m a CPA and I help over 800+ startups. In the past I’ve worked at Deloitte Tax and was the Controller of a 120+ employee startup. Our COO Scott Orn is a Kellogg MBA, former VC Partner at Lighthouse Capital Partners, and before that was an investment banker at JPMorgan. We have one of the largest tax teams focused on startups, and our clients are two times as likely to be acquired as the average startup.
Conclusion: Navigating California startup taxes
Understanding and managing California startup taxes is crucial for the success of your VC-backed company. While the tax landscape can be complex, proper planning and compliance can help you minimize your tax burden and avoid potential issues with the California Franchise Tax Board.
Remember to consult with a qualified tax professional or CPA who specializes in startup taxation to ensure you’re making the best decisions for your company’s specific situation. By staying informed and proactive about your tax obligations, you can focus on what really matters - growing your startup and achieving your business goals in the dynamic California market.
