California Business Taxpayers 1; Franchise Tax Board 0 (by guest blogger, Megan Hughes, of Business First Formations, Inc.)

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Hi … my name is Megan and I’m guest blogging for Diane this week. She’ll be back around September 16th. I’m the owner of Business First Formations, Inc., a company that helps business owners get their businesses set up and maintained.

I was encouraged this morning to read that the California Franchise Tax Board has finally given up on the idea that LLC income earned outside that state should be subject to California tax.

For those of you who are unfamiliar with this tax, one of the first hurdles business owners in California face is the franchise tax that is assessed over all businesses incorporated in that state or qualified to do business in that state. This is an $800 minimum fee that is payable each year, no matter whether your business makes a massive profit or posts a loss. It’s payable on April 15th of each year for all businesses set up from January 1 to April 15th, and “as soon as possible after formation” for all business set up between April 16th and December 31st. (Actually if you set up an S Corporation you don’t pay the franchise tax in the first year, but that’s another story for another day).

Now franchise tax isn’t unique to California – it exists in several other states as well, and is sometimes called a “privilege” tax (although why it’s a “privilege” to pay it escapes me). But in California, if your LLC grosses more than $250,000 per year you can expect to pay a second tax over and above the franchise tax. This gross earnings tax adds, at a minimum, another $900/year tax, and can go up to several thousands of dollars.

What made the gross earnings tax particularly unbearable to California LLC owners was the fact that the California Franchise Tax Board counted not only money made in California, but money made everywhere in the world. That calculation method has been the subject of a major court case which continues as we speak.

However, in the meantime the California Franchise Tax Board announced yesterday that for taxable years beginning after 2006 (which is outside the time period being litigated) the gross earnings tax calculation will no longer include earnings made outside the state or that can’t be attributed to work done within the state.

So what does this all mean? Well, it won’t save you from paying that basic $800/year franchise tax fee. I know that’s been a major source of confusion for folks – I’ve gotten plenty of emails asking me if the franchise tax will be going away, if this court case is successful. Sadly, the answer is “no.” But if you have been (a) fortunate enough to have a successful business, and (b) unfortunate enough to get caught in the California gross earnings trap, you may see some relief on your next tax bill.

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