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Calculating Your Business Tax Liability: Federal and California State Tax Law 

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States vary in their tax laws and in their allowable deductions for business owners. Because California’s state tax laws differ from federal tax laws, business owners in California should be attentive to ensure they comply with both the federal and state requirements.

Working with a qualified CPA who understands California tax law will help you reduce the risk of errors or red flags in your business tax return. Even with the help of a professional, it’s a good idea to have a basic understanding of the differences between your business’ federal tax liability and state tax liability.

If you own a California-based business, here are some of the top rules and regulations you need to be aware of.

There is more than one kind of business tax in California.

In California, there are three kinds of income taxes for businesses: corporate tax, franchise tax, and alternative minimum tax. While companies will be subject to at least one of these taxes, in California your business may be required to pay multiple income taxes. 

Federal tax rules ensure that corporations and Limited Liability Companies (LLCs) are subject to corporate tax, which hovers around 9% in California higher than the national average. Additionally, LLC types of corporations are required to pay an alternative minimum tax. 

California is one of the few states in the U.S. that imposes both personal and business taxes on small businesses set up as S-corporations and LLCs. In a number of other states, these business structures offer more benefit and a lower tax rate to business owners.

NOLs are treated differently under federal tax law.

Within federal tax law, the net operating loss (NOL) deduction is available to all corporate taxpayers according to IRC Sec. 172. This deduction is generally offered when a taxpayer’s total deductions amount to more than their total income for the year. NOLs are not deducted in the same year as they occur. Instead, they’re carried back or pushed forward to other tax years.  This ability to reallocate NOLs allows business owners to reduce debts.

Many states do not follow the federal rules provided for NOL deductions. California, in particular, does not adhere to federal guidelines and instead bases a corporation’s taxable income on money they have before the NOL deduction. 

California’s carryback and carryforward periods tend to be shorter than those allowed under federal law, (although there are exceptions for disaster losses and other specific situations). California business owners should be careful to follow the more limited state law in these cases, rather than inadvertently applying the more accommodating federal guidelines. Additionally, because California has suspended the NOL carryover deduction multiple times in the past, it’s important to work with a knowledgeable tax professional to ensure you are computing your NOL carryover correctly. 

Qualified small business stock may not be an option.

In most states, under Section 1202 of federal tax law, the sale of qualified small business stock (QSBS) held for at least five years can be excluded entirely from income. This offers businesses an opportunity to reap rewards without paying additional taxes. However, as of 2012, California no longer adheres to this federal tax guideline; the state does not allow any QSBS gain exclusion for stock sales made on or after January 1, 2013.

Casualty and disaster losses.

California tax law generally follows federal tax law when it comes to the treatment of losses incurred as a result of disaster or casualty. Under Publication 547, a casualty is defined as “the damage, destruction, or loss of property resulting from an identifiable event that is sudden, unexpected, or unusual.” To qualify as a disaster loss, the area where the disaster occurred needs to be eligible for assistance under the Disaster Relief and Emergency Assistance Act.

In California, your casualty loss becomes a disaster loss if you sustain an injury in an area where the Governor of California or the President of the United States has declared a state of emergency.

Special tax rules can apply to disaster losses, which can make it difficult for business owners to determine what they’re eligible for. Discuss your options with your CPA or tax attorney to get the best possible insight. 

Get California-Specific Tax Advice for Your Business

California is a wonderful place to reside, though when it comes to taxes, it can be a confusing place to operate a small business. Compared to other states, business taxes in California may seem strict or complicated to navigate; there are numerous regulations to consider that can complicate your tax returns. The best way to make sure that you get the most out of your tax return in California is to seek advice and guidance from professionals who are knowledgeable and experienced in California laws. 

If you have questions about your business tax return, or you find yourself the subject of a California EDD audit, reach out to our team of tax attorneys at Milikowsky Tax Law. We are not only experts in federal and state tax law, but have also been small business owners ourselves — we understand firsthand the ins and outs of running a business. Call us to receive trusted advice on everything from EDD questions to IRS and State tax audits to resolving existing tax debts and more.

The information contained on our website and in blogs is provided for information purposes only and does not constitute legal advice.

Resources:

https://www.caltaxadviser.com/

https://www.investopedia.com/terms/i/incometax.asp

http://www.answerconnect.cch.com/topic/0fc86db67c691000ab4a90b11c18c90202/net-operating-losses?searchId=247909028

https://www.ftb.ca.gov/forms/2018/18-540d-instructions.html

https://www.irs.gov/publications/p547