A limited liability company in general does not have to pay any business taxes. When we talk about the classification of LLC taxes in California, we know that it is a pass-through taxation structure. Typically, the profit LLC makes passes through the LLC to its members. Based on the profit share, members file their income tax returns. LLCs, unlike other corporations, do not have to pay income taxes based on profit or revenue.
IRS (Internal Revenue Service) allows LLCs to choose their preferable classification of tax at the beginning of the LLC formation. In general, a single-member LLC is taxed as a sole proprietor and a multi-member LLC is taxed as a partnership. As there is no fixed tax structure for LLCs, anyone certainly wants to opt for the most beneficial one. Keep reading till the end to know more about the tax structure of a California LLC and related aspects.
On this page, you’ll learn about the following:
- Classification of California LLC Taxes
- LLC Taxes to be Paid in California
- Default LLC Tax Classification Rules
- Options to Change Default Tax Classification
- Choosing a Classification for Your LLC
- Classification of LLC Taxes – At a Glance
Classification of California LLC Taxes
An LLC is considered a Pass-through Entity because it allows the income to pass through & become self-employment income. The members of the LLC have to pay Self-employment tax or Self-Employment Taxes on any income they earn through the LLC. The LLC has to pay Franchise Tax on its income. In addition to the Self-employment tax, there are some other requirements that an LLC has to consider, such as:
- Franchise Tax – Franchise tax applies to or levies upon LLCs, C-corporations, & S-corporations. Sole Proprietorship & Partnerships (directly owned by individuals) are exempted from the Franchise Tax. This tax is to be paid with the office of the Comptroller of Public Accounts.
- Federal Tax Identification Number – An LLC with employees must obtain a Federal Tax Identification Number. California does not have a separate State Tax Identification number.
- State Employer Taxes – If an LLC has employees on the payroll, it must pay state employer taxes in California. These taxes are handled through California Workforce Commission.
- Franchise Tax Report – In California, the LLCs do not file an annual report with the secretary of state; instead, it is submitted in the form of a Franchise Tax Report with the California Department of Tax and Fees.
Federal Tax Classifications
When LLCs were recognized as one of the types of Business Corporations, IRS did not create a new tax classification just for the LLC. LLCs were allowed to choose from the current tax classifications.
LLC Taxes to be Paid in California
An LLC in the state of California has to pay three types of taxes to the California Department of Tax and Fee Administration (CDTFA):
State Income Tax
A member of an LLC in California has to pay himself through the earnings. These earnings get reflected in your personal Tax return & are calculated at the time of paying the Income Tax.
Standard California State Income Tax rate ranging from 1% to 12.3% is applicable to your earnings. You get the opportunity to claim all the standard allowances & deductions upon filing the tax return.
State Sales Tax
The state of California levies Sales tax on tangible goods & some services provided by an LLC. The State Sales Tax is applied at the time of purchase & consists of three taxes: State Tax, Local Tax, & any District Tax applicable. The California State Sales Tax rate is 7.25%
State Use Tax
If an LLC is purchasing goods from other states to do business in California, it has to pay the State Use Tax of 7.25%
All corporations working in the State of California are required to pay California Franchise tax for the privilege of having a business in the State of California. The Franchise Tax is paid annually with the Franchise Tax Report. This tax is payable to the California Franchise Tax Board. The minimum Franchise Tax payable by an LLC in California is $800.
Federal Self-Employment Tax
Every member or manager of the California LLC earning profit from the LLC has to pay the Federal Self-Employment Tax (also called the Social Security or Medicare Tax). The Federal Self-Employment Tax applies to all the earnings of an LLC member or manager. The Federal Self-Employment Tax rate in California is 15.3%. To deduct your LLC’s expenses from the income earned, you must calculate the Self-Employment Tax your LLC owes.
Federal Income Tax
Like State Income Tax, this tax also applies to the earnings you make in your LLC. The Federal Income Tax Rate is subject to the earnings you make, the type of your LLC’s industry, the LLC tax bracket applicable, deductions applicable, etc.
Employee & Employer Taxes
Any LLC with employees on the payroll has to pay different kinds of taxes that apply to all the employees. The Employee & employer tax implications are different from all the other types mentioned above. For Example, All employees of an LLC have to collect and withhold the Payroll tax at the time of receiving the salary. Irrespective of whether you withhold the Federal Tax or not, each employee has to file an individual Tax return.
Default LLC Tax Classification Rules
By default, the LLCs are categorized as below (In both the categories, separate filing of income is not required):
Disregarded Entity (Single-Member LLC)
A single-member LLC is usually disregarded from the taxes. Hence a single-member LLC is also called a disregarded entity. Under the U.S. tax law, it is assumed that a single-member LLC is owned by an individual (& not by another LLC), so the U.S. tax law levies rules on it as a Sole Proprietor. Single-member LLC’s owner (Sole Proprietor) has to report all the income of the LLC via his own income tax return.
Sole Proprietorship Taxes
As mentioned earlier, the single owner of the LLC is treated as the Sole proprietor of the LLC & has to file the Self-Employment Tax on all of the LLC’s earnings. California does not levy State Income Tax, so a single-member LLC must file only the Federal Income Tax.
Partnership (Multi-Member LLC)
Any LLC with more than one owner is referred to as Multi- Member LLC & it is taxed as a partnership by default. Similar to the Single Owner or Single Member LLC, this LLC is also a pass-through entity. This means that the income of the LLC passes through the income of the members & they have to file taxes through their own earnings.
Partnership or Multi-Member LLC has to pay taxes similar to the Single Member LLC. If the Partnership LLC is directly owned by individuals, it is exempted from the Franchise Tax. All the members of the Multi-Member LLC are liable to pay Self-Employment Tax & Federal Income Tax.
Options to Change Default Tax Classification
The LLCs are categorized either as sole proprietorships or as partnerships, depending on the number of members the LLC has. This is the default tax classification applicable to LLCs. However, the LLCs have an option of changing the default classification & opting to register under the following categories for taxation purposes:
An LLC can prefer to be treated as a C-corporation by filing form 8832 (the Entity Classification Election Form) with the IRS. The C-corporation is a regular corporation that is subject to corporate taxes & it is not a pass-through entity.
An LLC taxed as a C-Corporation is not a pass-through entity. In a C-corporation, the members/shareholders/ owners are taxed separately. The shareholders of the C-corporation are taxed twice on the dividends that they earn. The dividends of the shareholders are taxed at the corporate level – with a Corporate Tax filed with Form 1120 & at a Shareholder level – an Income Tax filed with Form 1040. Shareholders are subjected to Federal Income Tax.
The S-Corporation is the most common type of corporate structure used by small businesses. It was created to provide corporations with limited liability protection while maintaining the benefits of being a separate legal entity. An LLC can prefer to be treated as S-Corporation by filing Form 2553. S-corporations are small business corporations, that choose to pass through the corporate income, losses, deductions, & credits to the shareholders for the purposes of Federal Taxes.
An S-Corporation is similar to an LLC except that it is treated by the IRS as a corporation for tax purposes. S-Corps do pay corporate income taxes; however, they are still considered disregarded entities for federal tax purposes.
Like an LLC, an S-Corp reports its annual earnings on a separate Schedule E on the member’s personal account. An S-Corp is treated by the IRS much like a partnership for tax purposes. Unlike Partnership, in S Corporation, the shareholders are required to pay Federal Self Income tax on their share of the company’s profits.
Choosing a Classification for Your LLC
In terms of owners’ protection against liability, perpetual existence, & savings in Taxation, Both LLCs (Limited Liability Companies) & Corporations are very much alike. However, with regard to formalities, Taxation, & capital, LLCs & Corporations differ in California.
Both LLCs and Corporations provide liability protection to their owners. The LLC provides protection against inside liability (towards the employee) & outside liability (towards the creditor). The Corporation usually provides only the inside liability.
Tax Classification Flexibility
For taxation purposes, an LLC has a choice of being treated as a sole proprietorship, Partnership or C-corporation or S-corporation. A corporation can choose to be treated only as C or S Corporation.
As mentioned earlier, the LLC can choose to be treated as a corporation; the Corporation does not have the option of being treated as the LLC. A California LLC is subjected to Franchise tax, Federal Income Tax, Sales & Use Taxes & State Employment Taxes (for LLCs that have employees)
A regular corporation or a C- Corporation is subjected to corporate tax, which can be filed through Form 1120 every year. The shareholders have to pay the Income-tax, only when they receive dividends from the Corporation. These dividends are taxed twice at the corporate level (on a corporate form)& at the shareholder level (on shareholder form).
An S- Corporation in LLC is not subjected to corporate taxes. But the shareholders are subjected to Taxation – even if they do not receive any dividends. A member of a California S-corporation has to pay Federal Self employment Tax only on his salary; any other profits that he makes through the LLC are not subject to the 15.3% Self Employment Tax.
Classification of LLC Taxes – At a Glance
|Points of Difference||LLC||S- Corporation||C-Corporation||Sole Proprietorship|
|Taxation||As an LLC, by default, there is no tax levied at the entity level. The members’ income or even the loss is passed through to members or owners.||Similar to LLC, no tax is levied on an S-Corporation at the entity level. The members’ income or even the loss is passed through to members or owners.||The C-Corporation is often taxed at the entity level. The Dividends are taxed at the shareholders’ level.||The Sole- proprietorship as an entity is not taxable. The Sole Proprietor pays taxes as an Individual.|
|Double Taxation||The LLC does not have Double Taxation||There is no Double Taxation in S-Corporation||There is Double Taxation in C-Corporation, only when the Shareholders earn in the form of dividends.||No Double Taxation in a sole proprietorship.|
|Self Employment Tax||The net income of the members or owners is subject to self-employment tax.||The salaries of the shareholder are subject to self-employment tax, but any other profits that the shareholder makes are not subject to the employment tax.||The C-Corporation is subject to self-employment tax.||The Sole-proprietorship is subject to self-employment tax|
|Pass-Through Income/Loss||An LLC is often referred to as a Pass-through entity because its income passes through/ passes to its members.||Yes, An S Corporation is a Pass-through Entity.||No, A C-Corporation is not a Pass-through Entity.||Yes, A Sole-proprietorship is a Pass-through Entity.|
How Do LLCs Pay Taxes in California
Any LLC operating in California is liable to pay 2 kinds of taxes- state taxes as well as federal taxes.
A Limited Liability Company (LLC) is a legally recognized business entity that provides entrepreneurs and business owners with the advantages of both a corporation and a partnership. LLCs are popular business structures due to their flexibility and potential tax savings. However, LLCs in California must still adhere to the state’s tax laws and regulations.
In California, LLCs are subject to the state’s Franchise Tax Board. LLCs must file the California Form 100, a document that provides information about the company’s income and expenses. This form is used to estimate the company’s tax liability. LLCs must pay this estimated amount before the tax due date or face penalties and interest.
LLCs are responsible for both federal and state taxes. All LLCs must pay federal income taxes, regardless of their profits or losses. California also imposes state income tax on LLCs. The tax rate is based on the company’s total taxable income for the year. LLCs that make over $1 million in annual income are subject to the state’s highest tax rate of 13.3%.
LLCs must also pay the California LLC Fee, which is based on the company’s total gross income. The minimum fee is $800, and the maximum fee is $11,790. The LLC Fee is due before the 15th day of the fourth month after the close of the taxable year.
LLCs must also consider their state payroll taxes. California requires LLCs to pay Unemployment Insurance and Employment Training Tax (ETT). The Unemployment Insurance tax is a percentage of the LLC’s total payroll, while the ETT is a flat rate of 0.1%.
California also requires LLCs to pay sales and use taxes. These taxes are based on the company’s sales of taxable items. LLCs must register with the Board of Equalization, collect the taxes from customers, and remit the taxes to the state.
LLCs must also consider their local taxes. LLCs are responsible for paying any local taxes imposed by the city or county in which they operate. These taxes may include business license fees, local sales taxes, and other taxes.
Finally, LLCs must adhere to the state’s filing requirements. All LLCs must file Form 568, the Limited Liability Company Return of Income, with the Franchise Tax Board before the 15th day of the third month after the close of the taxable year.
In conclusion, LLCs in California must adhere to the state’s tax laws and regulations. LLCs must pay federal and state income taxes, the California LLC Fee, payroll taxes, and sales and use taxes. They must also consider any local taxes imposed by the city or county in which they operate. Finally, all LLCs must file Form 568 with the Franchise Tax Board.
C-Corporation. It taxes the dividends of the shareholders at the corporate level as well as at an individual level.
An LLC is often referred to as the pass-through entity because the income or the assets pass through the members or owners of the LLC.
The LLCs have two default classifications. It can be termed as a single-member LLC or a multi-member LLC.
When choosing a different classification for taxation, it is essential to understand the liabilities & taxes applicable in that classification.
Every Tax classification has its own set of benefits & restrictions. Every state will have different taxation rules for each of the categories of business corporations. Depending on the objective of formation of the business entity (Eg. To avoid dual Taxation- one can choose S Corporation, for more flexibility, one can choose the LLC format). It is essential to understand the taxing structure of each country & each Classification; to decide how you wish to treat your LLC.