The reader should first read our article on Limited Liability Entities in California to determine the types of business entities available for persons desiring to do business in this State.

California has long had a reputation for being tax unfriendly to business within the State. This theory was predicated in large part on efforts of other states to entice business away from California, but it was effective enough propaganda so that many businesses incorporated in other States to avoid what was seen as unfavorable tax structures.

The problem with that approach is that California (and other States) tax based on where the business is conducted, not merely where documents are filed with the Secretary of State and few savings are usually obtained by incorporating out of State if you are planning to do business within the State.

But California found that this fact was not readily apparent to a skeptical audience and acted to further convince potential new businesses to incorporate in the State by what was a temporary (and now perhaps permanent) waiver of the minimum franchise tax for the first year of incorporation.

The workings of this waiver…and some of its oddities…are discussed in this article. Be sure to consult with competent counsel and accountants before actually incorporating.


The Basics of the General Application of the Minimum Franchise Tax

Like many states, California imposes a franchise tax on corporations and other business entities for the right to exist or do business within the state. The scope of this discussion will focus on corporate entities: “regular” C corporations, S corporations, and professional corporations. Generally, a professional corporation is controlled by the same provisions for “regular” C corporations. See Cal. Corp. Code §§13400-13410 and Cal. Rev. & Tax Code §§23001-23364a.

For the first year of its existence, a corporation must pay the applicable percentage of its net income. See rates below. Thereafter, the corporation must pay either its annual net income multiplied by the applicable tax rate, or the $800 minimum franchise tax, whichever is larger. Corporations are subject to the minimum franchise tax each year until formally dissolved.

California Franchise Tax Rate

C corporations……………… 8.84%

S corporations……………….1.5%

Professional corporations…… 8.84% unless S Corp tax status elected

* Banks and financial institutions subject to different rates.

Note that a corporation is required to pay the minimum franchise tax whether it is incorporated or organized in the state (domestic corporations); qualified or registered to do business in the state (foreign corporations); or doing business in the state without having incorporated, organized, registered or qualified under California law.

The minimum franchise tax is required of all corporations whether active, inactive, operating at a loss or filing a short-period return (less than 12 months).



There are three conditions under which the minimum franchise tax is waived: the First-Year Exemption, the15-Day Rule, and tax-exempt status.

1. First-Year Exemption.

California waives the first-year minimum franchise tax for new corporations that qualify or incorporate with the Secretary of State on or after January 1, 2000. Instead, corporations are liable for the applicable franchise tax on net income. Corporations become subject again to the yearly $800 minimum franchise tax starting their second taxable year until formally dissolved.

The first-year exemption does not apply to corporations that are not qualified by the California Secretary of State, or reorganize solely to avoid payment of their minimum franchise tax. It does apply to professional corporations.

2. 15-Day Rule “Short Accounting Period.”

A corporation whose first taxable year is a period of fifteen days or less has no filing requirement if it meets both of the following:

- Incorporates within the last 15 days of the their tax year, and
- Conducts no business during those 15 days.

Because the corporation is not required to file a return, this short accounting period is not considered the first tax year. The following tax year is considered the first taxable year and will be exempt from the minimum franchise tax.

Example: XYZ Corporation incorporates on December 22, 2010, and is a calendar year taxpayer. It did not conduct any business from December 22, 2010 through December 31, 2010. XYZ Corporation meets both conditions of the 15-Day Rule and does not have to file a 2010 return. Its first taxable year starts on January 1, 2011.

3. Tax-Exempt Status.

Entities may be granted tax-exempt status expressly by the California Constitution or by the California Franchise Tax Board (FTB). For more information see FTB Publication 927 “Exempt Organizations.” See also our article on Nonprofits.


Possible Amendments

Existing law contains no provision for when the First-Year Exemption will expire. In recent years, several assembly bills have modified or attempted to modify the current landscape. Assemblyman Garrick authored AB 327 and AB 2126 during the 2009/2010 Session. Both bills sought to lower the minimum franchise tax from $800 to $100, amongst other provisions. Both failed to make it out of committee.

From the same legislative session, AB 2671 (Cook) was successfully enacted on September 27, 2010. It waived the minimum tax for a sole proprietor who is a member of the U.S. Armed Forces under certain conditions.

There is currently no other legislation pending.



It is important to note that this benefit is restricted to California corporations and would not apply to corporations created out of state or other types of entities. The reason? Simple: this is an effort by the State to entice corporations back to California and out of the other states who seek to improve their own tax base.