California LLC Changes and Snags... Important!. - Posted by Bill Gatten

Posted by JPiper on January 25, 2001 at 14:01:11:

Can’t say that I’m too impressed with the LLC “snags” Bill. But I bet the weather is great out there!


California LLC Changes and Snags… Important!. - Posted by Bill Gatten

Posted by Bill Gatten on January 25, 2001 at 11:03:32:

I hate it when people post the same message on more than one site, but this seemed importnat enough to me to do so, so forgive me this time if your see it elsewhere (like on our site).

The following comes by way of our own Jim Pasquini, and is information that probably should be reviewed by anyone in California with an LLC or considering forming one. The LLC in Ca. is of course a VERY good thing, but with some gub’mental greedy new snags for those not in the know.

And if you have questions or further comments, I may be of no help, as I’m neither an attorney nor qualified to go much further than this.


In California LLC fees have been increased dramatically. The LLC fees that are paid by LLCs doing business in California, in lieu of corporate income or franchise taxes, were increased across the board by 73% in 1999 to offset the loss of tax revenue from allowing businesses to operate in LLC form, according to a recommendation by the California Franchise Tax Board. The LLC fees have been increased again for taxable years beginning on or after January 1, 2000, by approximately 20.4%.

Note that LLCs pay LLC fees in addition to minimum annual franchise tax (generally $800 a year).

As adoption of the LLC form of business becomes more prevalent in the future in California, resulting in more losses of corporate franchise tax revenues, you can expect the state to ratchet up LLC fees on an annual basis. The thought of losing any tax dollars as a result of allowing some types of businesses to operate in LLC form is apparently totally abhorrent to the powers-that-be in Sacramento.

On a more positive note, California’s LLC law was recently amended to at last permit formation of single-owner LLCs, beginning January 1, 2000, and it has conformed to the federal tax treatment of one-member LLCs. Thus, it now treats such LLCs the same as sole proprietorships, except that an LLC is still subject to the California minimum tax and annual LLC fee.

California has further reduced the corporate minimum franchise tax on new corporations. For new corporations formed on or after January 1, 2000, no minimum franchise tax prepayment is required for the first two taxable years.

Since the franchise tax is based on the prior “income year,” under previous law a new corporation had to pay at least $1,600 minimum tax for its first year of operations, a doubling of the tax, since there was no prior income year before it incorporated (or else paid $300 for the initial year and $500 for the “second” year in the case of certain small Qualifying New Corporations). Thus, the new provision will save a new corporation that pays only the minimum tax at least $800, and perhaps $1,600, in franchise tax for its first year of operations.

Tax trap! California’s tax laws regarding limited liability companies (LLCs) are already among the most restrictive in the country, as LLCs are only permitted for a narrow range of businesses (those not requiring state licenses of any kind), and LLCs must pay both a hefty annual “LLC fee” and an annual $800 minimum tax. However, LLC owners in California may soon be in for a rude shock if they operate their business using the cash basis of accounting for income tax purposes.

Under federal income tax laws regarding tax shelter accounting methods, a business entity is automatically categorized as a “tax shelter,” regardless of the reality of the situation, and thus required to use the accrual method of accounting for income tax purposes, if it is required to be registered with any federal or state securities agency. (An exception is made for C corporations.) Note that under California’s securities laws, an ownership interest in an LLC is considered a security that must be registered, unless every member (owner) of the LLC is actively engaged in management.

Thus, if your business operates as an LLC in California, and has even one member who does not have management responsibility (such as a passive investor), it appears that California law would cause the LLC to be classified as a “tax shelter” for both federal and California tax purposes, and thus required to use the accrual method of accounting. LLCs that unwittingly adopt the cash method of tax accounting could be in for some nasty surprises if the IRS or the Franchise Tax Board audits them and determines that they should have been using the accrual method for the last few tax years.

If your business is an LLC operating in California and it has non-management members, consult your tax advisor immediately with regard to this potential TAX TRAP.

C’mon, Bill, the state has to find SOME way… - Posted by ScottE

Posted by ScottE on January 25, 2001 at 23:25:20:

to pay for all of that electrictity…and they continue to blame (pseudo) deregulation instead of the real reason-NOT allowing the construction of new power plants in years.

The California government may take Flori-duh’s place in the race for stupidity.