Congratulations on making the choice to incorporate your small business! You’re probably as excited as a kid on Christmas to get things moving forward when the thought hits, “I could actually make this my Christmas present!” Well you might want to wait an extra week and I’ll tell you why.
In most states, including California where I live, the taxing agency levies a minimum annual tax just for doing business in the state. Thanks, right? Here’s the relevant text:
Corporation Franchise Tax
Entities subject to the corporation minimum franchise tax include all corporations (e.g., LLCs electing to be taxed as corporations) that meet any of the following:
- Incorporated or organized in California.
- Qualified or registered to do business in California.
- Doing business in California, whether or not incorporated, organized, qualified, or registered under California law.
The minimum franchise tax must be paid by corporations incorporated in California or qualified or registered under California law whether the corporation is active, inactive, not doing business, or operates at a loss. See General Information C, Minimum Franchise Tax, for more information.
The measured franchise tax is imposed on corporations doing business in California and is measured by the income of the current taxable year for the privilege of doing business in that taxable year.
Did you read that last line? “for the privilege of doing business in that taxable year.” Don’t get me started. This is from the tax Form 100 instructions that details regular C-corporations but is nearly identical to the text in the Form 100S that covers S-corporations.
Anyway that minimum franchise tax in CA is $800, so if you incorporate in January you pay it for the entire year and if you incorporate in December you still pay it for the entire year. Hmmm. Add on the reporting fees and registered agent fees and you’re talking around $1,000. So when is the best time of year to incorporate?
January. At least that’s the short answer, but there’s another factor you may want to consider as well:
If your company is going to be making a lot of money – say an additional $50,000 between now and the end of the year – then you probably want to incorporate now instead of waiting for January. Why? Well you did read my previous article that showed you how to save thousands every year didn’t you? If not feel free to do it now and I’ll wait.
Clearly if you’re earning enough you’re going to benefit by incorporating now. Any savings over $1,000 and you’ll come out ahead. You’re going to want to check the fees in your state of course and do the math. California is probably one of the more expensive states so it may not be as large of an issue where you live.
Is there a day in January I recommend? Just as soon as possible so you can get your financials transferred over to the corporation and close the books on your sole proprietorship.
How quickly does California process incorporations? The minimum I’ve seen is 2 weeks, so theoretically you could make it a Christmas present to yourself and it wouldn’t be processed until the following month, but I wouldn’t. I’ve been hit by the end-of-year processing before…
You see, CA knows that your application for incorporation is going to make the state an additional $800 if they can process you before December 31 and believe me they’ll try to finish up as many as they can. It’s just not worth it. Time your submittal to show up on someone’s desk on January 2 and you’ll be just fine.
To recap: if you’re going to be earning at least $50,000 before the end of the year you can incorporate now, otherwise your best option may be to just wait until January.