California small business owners need to understand the state business taxes when selling a business. The state levies higher-than-average taxes on both business and personal income. California is one of the few states that imposes both business and individual taxes on small business owners. This applies to those who set up their businesses as pass-through entities, such as S corporations or limited liability companies (LLCs).
Businesses formed under one of these designations will be exempt from federal income tax. This is because the income they earn passes through to the business owners. The IRS views it as double taxation to tax both the business owners on the pass-through income and the business itself. As a result, the federal government taxes only the business owners at their income tax rates. Most states adhere to this same rationale. However, California is one of a handful of states that gets these business owners from both sides.
California’s double taxation can increase a small business owner’s tax burden by as much as twice the amount. This depends on several factors, including the net income of a pass-through entity. It also depends on the amount of personal income generated by the business from its owners. Given the state’s very high cost of living, the tax treatment of small businesses in California creates unique challenges for entrepreneurs and small business startups.
Here’s an overview of the types of state business taxes imposed upon business owners. Remember that, in addition to California’s state tax scheme, if your company also does business in Nevada or Arizona, those states will have different tax requirements. They also have different methods of calculating each tax that you’ll need to consider.
State Income Taxes
Forty-four states impose a corporate income tax, including California. Traditional corporations and LLCs that elect to be treated as corporations are subject to a California income tax rate of 8.84% on their net income from business transactions within the state. Businesses structured as C corporations will file a tax return for the company. This return is required to pay taxes on its profits. Otherwise, as mentioned above, owners of businesses created as LLCs, S corporations, general partnerships, and sole proprietorships will pay taxes on an individual level. The company profits pass through to the owners’ taxes.
Nevada, Ohio, South Dakota, Texas, Washington, and Wyoming are the six states that do not have corporate income taxes. If you have a company branch in these states, no corporate tax filing is necessary. However, some states (Nevada, Ohio, Texas, and Washington) impose a tax on gross receipts. There’s no such thing as incorporating your business in a “tax-free” state to avoid all state taxes. You must comply with the state tax law in whatever state(s) you’re doing business. Your California-based company with a subsidiary incorporated in Nevada must still pay California state taxes on your income earned.
Franchise Tax
While this state tax may seem to pertain specifically to franchise businesses, it’s merely a tax for the privilege of doing business there. In California, an annual franchise tax of $800 applies to almost every LLC registered to do business in the state. It even applies if your company operates at a loss for the year.
Sales Tax
If your business sells taxable goods or services, you are required to collect sales tax from customers and remit it to the California Department of Taxation. The state business taxes owed are calculated by applying the state’s applicable tax rate to the total sales price of the goods or services. California has a statewide sales tax of 7.5%.
If you’re selling goods or services to customers in multiple states, you must determine which sales are subject to state sales tax. Generally, you aren’t required to collect sales tax unless you have a physical presence in that state. This could be an office or a store in the state, taking orders or performing services in the state, or you own or lease property there.
Property Tax
Typically, this tax is levied by the municipality or county assessor. Each county in California collects a general property tax equal to 1% of assessed value. This general tax is the single most significant tax. However, other smaller taxes vary by city and district. For example, in Sacramento County, the average overall tax rate, including bond debt, is around 1.1%.
Any business in California that owns personal property and/or fixtures with a total combined cost of $100,000 or more must file a BPS, even if the County Assessor doesn’t request that you file one.
Certain types of personal property, including household furnishings, personal effects, and business inventory, are exempt from taxation. However, business personal property, privately owned or business-owned boats, and aircraft aren’t exempt under the law.
Ensure you have a solid understanding of taxes and a solid strategy for your business.
Contact a Business Expert
Andrew Rogerson serves clients who are business owners and prospective business owners throughout California. If you have questions about business taxes and business opportunities in the state, Andrew can help answer them. Take some time to speak with Andrew about valuing and selling a business in California. Contact Andrew via email or Call Toll-Free at (844) 414-9700.