Is the California LLC Fee Tax Deductible?
Learn the different rules for deducting California LLC fees on federal vs. state tax returns to ensure your business files accurately.
Operating a Limited Liability Company (LLC) in California involves several mandatory payments to the state. A common question for business owners is whether these costs, specifically the annual LLC fee, can be written off on their tax returns. The answer depends on whether you are filing a federal or state tax return, as the rules differ significantly. This distinction is important for proper tax compliance and financial planning.
Differentiating California LLC Taxes and Fees
To understand deductibility, one must distinguish between the payments an LLC makes to the California Franchise Tax Board (FTB). The first is the annual franchise tax, a fixed $800 payment required from every LLC in California, regardless of whether the business generates income or is actively operating. This tax is for the privilege of doing business within the state.
Separate from the franchise tax is the annual LLC fee. This payment is calculated based on the LLC’s total gross income earned in California and applies only to LLCs with income of $250,000 or more. The fee is tiered, starting at $900 and increasing to $11,790 for incomes of $5,000,000 or more.
A third payment is the one-time filing fee paid to the Secretary of State when the LLC is formed. This initial expense is treated as a startup cost and is distinct from the recurring annual tax and fee.
Federal Tax Deductibility
For federal income tax purposes, the annual franchise tax and the annual LLC fee are deductible. The Internal Revenue Service (IRS) allows businesses to deduct state and local taxes as ordinary and necessary business expenses, and both the $800 franchise tax and the income-based LLC fee fit this description. These expenses reduce the business’s net taxable income reported to the IRS.
The location for claiming this deduction depends on how the LLC is classified for tax purposes. An LLC is a state law entity, but for federal taxes, it is treated by default as a partnership (for multi-member LLCs) or a disregarded entity (for single-member LLCs). LLCs can also elect to be taxed as an S Corporation or C Corporation.
California State Tax Deductibility
In contrast to federal rules, California does not permit LLCs to deduct either the $800 annual franchise tax or the annual LLC fee on their state tax returns. The California Revenue and Taxation Code prohibits the deduction of taxes based on income or the privilege of doing business within the state.
Since the franchise tax is for this privilege and the LLC fee is based on gross income, they fall under this restriction. This means an LLC cannot subtract these payments when calculating its taxable income for the FTB.
How to Claim the Deduction
The process for claiming the federal deduction varies by the LLC’s tax structure. For a single-member LLC treated as a disregarded entity, the owner files a Schedule C (Form 1040), “Profit or Loss from Business.” The total of the franchise tax and any LLC fee is entered on Line 23 for “Taxes and Licenses.”
If the LLC is a multi-member entity taxed as a partnership, it files Form 1065, “U.S. Return of Partnership Income,” and takes the deduction on Line 14. For LLCs that have elected to be taxed as an S Corporation, the deduction is reported on Form 1120-S, “U.S. Income Tax Return for an S Corporation,” on Line 12.