eMinutes Blog

Forming a California LLC? New Tax Exemption Starts in 2021

July 15, 2020

A vaccine is not the only good news expected in early 2021.  California just encouraged a surge in LLC formation by exempting newly-formed LLCs from the $800 franchise tax – so long as they form after the first of the year.

California law generally imposes an annual minimum franchise tax of $800 on every corporation incorporated, qualified to transact business, or doing business in California.[1] As we’ve noted before,[2] a corporation that incorporates or qualifies to do business in California does not have to pay the minimum franchise tax in its first taxable year.[3] As we discussed in our prior article, a taxable year includes any period of more than 15 days, so entrepreneurs forming a new corporation in California at the end of a year need to be careful to incorporate only inside of the last 15 days of the year to take full advantage of the exemption from having to pay the minimum annual franchise tax in the corporation’s first taxable year.

Business entities other than corporations are likewise subject to payment of the $800 annual minimum franchise tax.[4] Until now, however, business entities other than corporations have not enjoyed the benefit of that same tax exemption for an entity’s first taxable year. But on June 29, 2020, Governor Newsom approved Assembly Bill (“A.B.”) 85, which amended the California Revenue and Taxation Code to extend the exemption to limited liability companies (“LLCs”), limited liability partnerships (“LLPs”), and limited partnerships (“LPs”), for a three-year period at least.[5] In enacting A.B. 85, the Legislature specifically noted that its goal was “to help and reduce costs for first-year California small businesses.”[6] In particular, the Legislature noted that the minimum franchise tax of $800 payable by LLCs, LLPs, and LPs “may be difficult to afford for first-year businesses” and, as such, “may stifle economic growth and job creation and may inhibit the formation of many small businesses.”[7] Consequently, the Legislature determined that it made sense to extend the exemption from payment of the minimum annual franchise tax to business entities other than corporations during their first year in business, at least for a three-year test period.[8]

As it currently stands, the exemption only applies to LLCs, LLPs, and LPs that are formed or registered to do business in California “on or after January 1, 2021, and before January 1, 2024,” that is, during the years 2021, 2022, and 2023.[9] Therefore, while we generally advise entrepreneurs wishing to form a new corporation in California at the end of the year to do so during the last 15 days of the year to take full advantage of the exemption from paying the $800 minimum annual franchise tax during their first year in business, entrepreneurs wishing to form a business entity other than a corporation at the end of this year should actually wait until after the New Year to have the benefit of the same tax exemption that was previously unavailable to them. By waiting just a few days or weeks, the entrepreneur will save $800 in start-up costs, just as the Legislature intended.

[1] See Cal. Rev. & Tax. Code § 23153(b), (d)(1).

[2] See eMinutes Blog, “Timing Is Everything When Incorporating in California at the End of the Year” (Oct. 12, 2016).

[3] See Cal. Rev. & Tax. Code § 23153(f)(1).

[4] See id. §§§ 17935(a) (limited partnerships), 17941(a) (limited liability companies), 17948(a) (limited liability partnerships).

[5] See id. §§§ 17935(f)(1) (limited partnerships), 17941(g)(1) (limited liability companies), 17948(e)(1) (limited liability partnerships).

[6] A.B. 85 § 24(b)(1) (June 29, 2020).

[7] Id.

[8] A.B. 85 requires that the Franchise Tax Board submit annual reports to the Legislature indicating the number of first-year corporations, LLCs, LLPs, and LPs that are affected by the exemption. Id. § 24(b)(2), (3); see also Cal. Rev. & Tax. Code § 41(a) (setting out certain requirements for bills introduced on or after January 1, 2020 that would authorize an exemption from taxes, including that the bill identify (1) the specific goals, purposes, and objectives that the tax exemption will achieve, and (2) detailed performance indicators for the Legislature to use when measuring whether the exemption meets those goals, purposes, and objectives).

[9] See Cal. Rev. & Tax. Code §§§ 17935(f)(1) (limited partnerships), 17941(g)(1) (limited liability companies), 17948(e)(1) (limited liability partnerships).

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