Looking to cut costs? Start with your LLC

Virtually everyone these days is looking for ways to save some money, and the first place to look for California investors should be your LLC.California notoriously taxes LLC gross revenue. See The Knee-Jerk LLC. The “gross receipts” fee can range from $800 (for annual gross receipts less than $250,000) to as much as $12,590 (for annual gross receipts greater than $5 million) per year. Corporations and limited partnerships, on the other hand, are subject to a flat $800 annual franchise tax, and new corporations are exempt from the $800 minimum franchise tax, but still subject to the 8.84% tax on any taxable income. In other words, the LLC “gross receipts” fee is seriously gross!

In a lousy economy, everyone is looking for a way to save a buck. The first place to start is your LLC. This article will benefit two types of LLCs owners: (1) LLC owners who should’ve formed a corporation rather than a LLC, and (2) LLCs owners who have multiple LLC with revenue that triggers the gross receipts fee.

A Pet Shop Does Not Need to be a LLC

Peter and Lillian own a pet shop with $2 million in gross revenue. Peter and Lillian are a sweet married couple, who are throwing away $6000 each year in gross receipts fees. Although LLCs have developed a certain sex appeal and have become the “knee jerk” reaction to new business formation, it’s important to recognize that in California a LLC can pay a lot more in taxes than a corporation, because of the gross receipts fee. In fact, a LLC should be an entity of last resort – not a first choice, and only used in situations where, for example, an S-Corp is not available, depreciable real estate is involved, or the business structure requires flexibility not available in a corporation.

There might be a few special situations where it’s worth it and necessary to pay the gross receipts fee, but if your company does not have to be a LLC (like Peter and Lillian’s pet shop), and its annual gross revenue exceed $250,000, save some money by converting to a S-Corporation. The transaction should be analyzed by your CPA, but in general the process is simple (new corporate documents are prepared, membership interests are converted to shares of stock, and Articles of Incorporation with a statement of conversion are filed with the Secretary of State). A word of caution – it’s not a great idea to simply elect to be treated as a corporation by filing a federal tax election. Do it right, convert the LLC to a corporation properly, and stop paying the gross receipts fee.

Lotsa LLCs Means Lotsa Gross Receipts Fees

About three years ago, I was contacted by a real estate investor who had quickly formed 11 LLCs to own some very substantial office buildings in Los Angeles. The investor’s annual tab for gross receipts fees was $74,800 – even worse, a couple of these properties were losing money. By converting each of these LLCs to limited partnerships (and forming three corporations to act as the general partners of these limited partnerships), we reduced the annual fee from $74,800 to $11,200 – an annual savings of more than $60,000! While there are some costs associated with this sort of restructuring (ranging from lender’s consent to title insurance), the substantial annual savings is worth the cost.