space

5. FINANCIAL MATTERS

d. Taxes

Taxpayer I.D. Numbers

Except for LLC's with only one member, every LLC, LP, and corporation needs its own taxpayer identification number. Obtain one for your new company or fund from the IRS website. You will need the number for the federal tax forms and returns of the entity. Your entity may also need I.D. numbers from state and local tax agencies. For example, in California the Employment Development Department issues I.D. numbers to employers (i.e., those companies with "employees" as opposed to "independent contractors").

Tax Treatment

At the federal level, the following entity types are taxed as indicated, unless they elect to be taxed as a corporation.

Type of Entity	Default Status
sole proprietorship	disregarded entity
general partnership	partnership
limited partnership	partnership
LLC with only one member	disregarded entity
LLC with more than one member	partnership
S corporation	partnership
C corporation	corporation

Income Taxes

If your entity is taxed as a disregarded entity or partnership, it will not pay income tax at the federal level. However, state and local governments may tax income from sources within their jurisdictions. For example, California imposes a “gross receipts tax” on LLC's and a net income tax on “S corporations”. The LLC tax varies from $900 to $11,790 and applies to gross revenue of $250,000 or more. The “S corporation” tax is 1.5% of the California-sourced net income (if any).

If your entity is taxed as a corporation, it must pay income tax at both the state and federal levels. The corporate income tax rates are 15-35% at the federal level and 8.84% in California.

The owners of a company are generally required to pay personal income taxes at the state and federal levels on compensation for services, dividends (in the case of a “C corporation”), or allocations of net income (in the case of entities taxed as partnerships). Owners of an LLC, LP, or “S corporation” may incur tax even if the allocated income is not actually distributed to them. The income of the entity is taxed as ordinary income or capital gains, depending on the underlying source of the income.

Applicable law may require a taxpayer to make estimated tax payments periodically throughout the year.

Franchise Taxes

States may impose franchise taxes on business entities within their jurisdictions. For example, California generally imposes a franchise tax of $800 on LLC's, LP's, and corporations registered in the state.

In the case of LLC's and LP's, the initial franchise tax is due on the 15th day of the fourth month following the date of registration in California. In subsequent years, the tax is due on the 15th day of the fourth month of each year. In the case of corporations, the franchise tax is waived for the first year and then due on the 15th day of the third month of each year.

Companies organized in Delaware must pay a franchise tax to Delaware. The franchise tax for Delaware LLC's and LP's is $200 and is due by June 1 of each year. The franchise tax for all Delaware corporations (both “C” and “S” types) varies from $35 to $165,000 and is due by March 1 of each year.

Employment Taxes

If your company has any employees, it must withhold payroll taxes from the taxable wages of the employees. Companies are not required to withhold any taxes from independent contractors. At the federal level, payroll taxes cover income tax, Social Security, Medicare, and unemployment insurance. In California, the payroll taxes cover income tax, employment training, state disability, and unemployment insurance. Companies must also pay match the withheld amounts to some extent.

Your company must pay the withheld and matching amounts to the tax agencies pursuant to the required schedules.

The individual owners of your company must pay self-employment tax on their “active” income from participating in the company. The self-employment tax includes amounts for Social Security and Medicare. It does not apply to “passive” income such as rent, capital gains, interest, and distributions from passive investments. In the case of an LLC, LP, or “S corporation”, self-employment tax applies to allocations, not distributions.

Sales and Use Taxes

Sales and use taxes exist at the state but not federal level. In California, retailers must obtain a seller's permit from the State Board of Equalization and pay sales tax on the retail sale or lease of tangible personal property within the state. In addition, California imposes a “use tax” on all out-of-state sales or leases of goods that will be used, consumed, or stored within the state. The obligation to pay the use tax usually falls on the user, not the out-of-state seller.

Property Taxes

California counties impose an annual tax on certain personal property and “real property” (real estate) held by businesses. Property taxes exist only at the county level, not the state or federal levels. However, the California Board of Equalization plays a role in the administration of property taxes.

Other Taxes

Additional taxes and fees may apply to your business. For example, California administers programs such as excise taxes, fuel taxes, and environmental fees. Contact the California Board of Equalization for more information regarding those programs.