While California has a lot going for it when it comes to running your own business, including a strong economy, desirable weather, and an educated workforce, it’s not known as one of the cheapest places to do business. 

When it comes to business taxes, it’s also not one of the lowest cost states. That’s why small business owners in California will want to make sure they are taking advantage of tax deductions to reduce the amount of tax they owe.

Importance Of Understanding And Utilizing Deductions For Business Owners

California business taxes aren’t the highest in the nation, but they carry some unique features that potentially make taxes quite costly. Some businesses that are not based in California may also face tax liability in the state, due to the way the state of California taxes certain businesses that do business there.

Because tax and personal tax rates are high, it’s important for business owners as well as individuals who are required to pay taxes in California to understand and take advantage of opportunities to reduce their taxes through tax deductions, when available, tax credits.

Introduction to California Business Tax Deductions

How your business will be taxed in California depends in part on the type of business you operate. We will discuss these in more detail in a moment. 

While both tax deductions and tax credits are often referred to as tax breaks, they work a little differently. 

Tax deductions reduce your taxable income, while tax credits directly impact the amount of tax owed. Many common small business  tax deductions may apply to both federal income taxes and California state taxes. In many cases, taxpayers will review federal tax form instructions from the Internal Revenue Service to understand available deductions. 

The California Revenue and Taxation Code often follows federal tax law on the deductibility of common business expenses we will discuss here. 

Types of Business Entities and Their Tax Implications

How you operate your business may affect your tax bill. This topic can get quite complicated so it’s important to talk to a qualified tax professional to understand how your choice of business entity may impact your taxes, both at the state and federal level. But here are a few things to keep in mind. 

Sole Proprietorships

A sole proprietorship is the easiest way to go into business as it doesn’t require filing any formation documents with the State of California, or at the federal level. (If your business operates with a name different from your name though, you must file a fictitious name with the state.) 

In this type of business, there is no separate legal entity and taxes flow through to the taxpayer’s personal tax return. 

Limited Liability Company

An LLC may be taxed in different ways, depending on the number of members (owners) and elections the business makes in terms of how it chooses to be taxed. In California, an LLC must have the same classification for both state and federal tax purposes. 

An LLC will be considered a disregarded entity if it has just one member and does not elect to be taxed as a corporation. Like a sole proprietorship, taxes on a disregarded entity flow through to the owner’s personal tax return. 

It may also be treated as a partnership (limited liability partnership, limited liability limited partnership, or series limited liability company) if it has more than one member and does not elect to be taxed as a corporation. 

An LLC may elect to be taxed as a corporation, and some business owners find they can save money on taxes by choosing to be taxed as an S corporation.

LLCs that are organized in California or do business in California must pay the annual franchise tax of $800. This is in addition to other taxes. 

S Corporations

If your LLC or corporation qualifies, it may choose to be taxed as an S corporation by filing an election with the IRS. 

An S corporation is a pass-through entity, which means income, losses and deductions flow through to the owners’ personal tax returns. California charges S corporations that have California source income a tax rate of 1.5% 

S Corporations located in California or considered to be doing business in California must pay the annual franchise tax of $800. 

Find out if your out–of-state business is considered to be doing business in California by reviewing the guidelines here. 

Corporations 

Unlike the pass-through entities mentioned above, corporations (except S corporations) file their own tax return and pay their own taxes. Owners (shareholders) are taxed on dividends. 

Corporations that are incorporated in California, do business in California, are registered in California or who have California source income are required to file a California Corporation Franchise or Income Tax Return (Form 100). California corporations have a tax rate of 8.84% (except banks and financials) and must pay a minimum franchise tax of $800. 

The Most Important California Business Tax Deductions

Remember that the IRS standard for a business tax deduction is that the expense must be both ordinary and necessary. The same principle applies to small business tax deductions in California. 

An ordinary expense is one that’s common and accepted in your trade or business. A necessary expense is one that’s helpful and appropriate for your trade or business. 

Marketing And Advertising Expenses

California generally follows the same guidelines for the tax deductibility of marketing and advertising expenses as the IRS. These are spelled out in IRS Publication 535, Business Expenses. 

Business owners generally may deduct reasonable advertising expenses directly related to business activities. That may also include deductions for the expense of goodwill advertising if the business owner reasonably expects the business to benefit in the future. (For example, sponsoring a local school sports team may qualify.) 

There are certain advertising or marketing expenses that don’t qualify, including lobbying expenses, bribes or kickbacks. 

Vehicle or Car Expenses

Here California generally follows the same guidelines spelled out in IRS Pub. 463, Travel, Entertainment, Gift, and Car Expenses. 

If you use your car or truck to make business-related trips to customers or attend business meetings away from your regular workplace, to travel from one workplace to another, or to travel to temporary workplaces, related expenses may be deductible.

If you use your vehicle for both business and personal use, you must divide your expenses based on actual mileage for business use. Business owners have the choice of either using actual expenses (prorated) or the standard mileage rate. 

For 2023, the IRS standard mileage rate is 65.5 cents per mile driven for business use.

Self-employed individuals may also be able to deduct the business portion of state and local personal property tax on the car, parking fees, and tolls, and car loan interest regardless of whether you claim the standard mileage rate. 

Travel & Entertainment Expenses

While entertainment expenses are no longer deductible at the federal level, California does not comply with federal law here. In California, entertainment expenses may be deductible if they meet one of two tests (the “directly related test” or the “associated test”). These deductions, however, are limited to 50% of unreimbursed expenses and business owners must maintain proper documentation.

Home Office Expenses

The home office deduction can be a valuable tax deduction for those who use a portion of their home exclusively and regularly for work, and California follows the federal guidelines described in IRS Publication 587, Business Use of Your Home. 

In addition to the regular and exclusive use requirement, The business part of your home must be your principal place of business; A place where you meet or deal with patients, clients, or customers in the normal course of your trade or business; or a separate structure (not attached to your home) used in connection with your trade or business.

If you qualify you may deduct actual expenses or choose to take the safe harbor deduction of $5 per square foot for up to 300 square feet (or $1500 total). 

Employee Wages And Benefits

Business owners can generally deduct the wages paid employees for services they perform for the business.

Note that California businesses that pay wages for employment to one or more people in excess of $100 during any calendar quarter are considered an employer in California. The business must register for an Employment Development Department (EDD) payroll account and follow payroll tax and reporting requirements. 

Fringe benefits are often tax deductible as well. California’s deductions are a little different than federal deductions here. For example, under federal law no deduction is allowed for transportation expenses that are the equivalent of commuting for employees (e.g., between the employee’s home and the workplace), except as provided for the safety of the employee. But California does not conform to federal law here.

Business Insurance

The cost of business insurance premiums are often tax deductible, if they are ordinary and necessary expenses for your business. However some insurance expenses must be capitalized. California follows IRS rules here, so review the instructions for deducting insurance in IRS Publication 535. 

Examples of insurance premiums that normally are deductible include: 

• Business liability insurance
• Business interruption insurance
• Business property insurance for fire, theft, storms, accidents etc.
• Group medical insurance for employees
• Worker’s compensation insurance premiums
• Malpractice insurance
• Vehicle insurance for vehicles used in the business (see caveat below)
• Life insurance on business owner or employee (see exception below) 

If you are self-employed, you may be able to deduct the cost of medical and dental insurance and qualified long-term care insurance for yourself, your spouse, and your dependents. If you obtained insurance through the Health Insurance Marketplace, you’ll need to use the worksheet in IRS Publication 974 to calculate your deduction. Otherwise you can use the worksheet in Publication 535. 

Car insurance is only a deduction if you use the actual expense method, not if you use the standard mileage deduction.

You cannot deduct the cost of life insurance coverage for you, an employee, or any person with a financial interest in your business if you’re directly or indirectly the beneficiary of the policy.

Depreciation and Section 179

Depreciation allows a business to write off the cost of certain purchases over time. Section 179 is a provision in the federal tax code that allows businesses to purchase certain types of tangible personal property and deduct some or all of the cost in the year it was put into service, instead of depreciating it over time. 

Under Section 179, businesses may be able to deduct property such as equipment, machinery, furniture, vehicles or buildings (but not land). Other types of intangible property may qualify, such as computer software, copyrights or patents, copyrights.

Bonus depreciation allows qualifying businesses to take additional depreciation on new and used equipment (at the federal level) as long as the used equipment is new to the business taking the bonus depreciation. This is being phased out until 2027. 

There are some differences between California and federal taxes when it comes to depreciation. California does not conform to the federal rules regarding special or bonus depreciation, for example. You can review the differences in FTB Publication 1001 Supplement to California Adjustments or discuss this with your tax pro. 

Charitable Contributions

Businesses may contribute to charitable organizations, either through cash payments, donations or the donation of property and equipment. California mirrors federal income tax guidelines found in IRS Pub. 526, Charitable Contributions.

Businesses may be able to deduct charitable contributions subject to limits: up to 50%, 30%, or 20% of adjusted gross income depending on the contribution and organization. Corporations (except S Corporations) should refer to the instructions for IRS Tax Form 1120 while sole proprietors, partners in a partnership, or shareholders in an S corporation will use Schedule A (Form 1040). Contributions must be made to qualifying organizations and not to individuals. 

What may seem like a charitable contribution may sometimes qualify as a business expense, and it’s important to know the difference. If, for example, you pay for an ad in a newsletter or directory for a non-profit or church, and you expect that ad to bring in business, that would likely be an advertising expense, not a charitable contribution. 

It’s also worth noting here that California limits the amount of charitable deduction to fifty percent of federal adjusted gross income, not sixty percent as under federal law.  But California’s standard deduction is lower than the federal standard deduction, which means Californians may benefit from itemized deductions, including charitable contributions at the state level even if they don’t benefit at the federal level. (This does not apply specifically to businesses.) 

In addition to these common tax deductions businesses may be able to deduct interest on small business loans, utilities, supplies and materials, start-up costs, legal and professional fees, rent, salary, gifts and more.

Common Mistakes to Avoid When Claiming Tax Deductions

Missing out on tax deductions is a common mistake you’ll want to avoid. If you’re working with a trusted tax professional they should be able to help you take advantage of tax deductions at the state and federal level. 

Tax software will also walk you through questionnaires designed to help you take advantage of tax deductions. 

Failing to keep good records also trips up business owners. Use a separate business checking account for business income and expenses, along with a business credit card so you don’t overlook expenses you’ve paid. Keep copies of receipts for each deduction you take. 

How Can I Avoid A Tax Audit For My California Business?

While there is no way to completely avoid a tax audit, there are ways to help reduce the changes your tax return is flagged for an audit. 

The top way to do this is to file an accurate tax return, and to do so by the tax filing deadline. Using accounting software and keeping your bookkeeping up to date throughout the year can help you avoid mistakes if you rush to complete your return by the deadline. 

Working with a tax professional (CPA, enrolled agent or other tax pro) can help you file an accurate return, but you must provide them with accurate information to begin with. Again, carefully tracking business income and expenses throughout the year and keeping good records can go a long way toward this goal. 

Other red flags may include high home office deductions, larger than typical charitable deductions, or missing income. 

What Is The Deadline For Filing California Business Taxes?

There are a number of deadlines, depending on the type of tax your business is required to pay. However, here are the main deadlines most business owners must observe. 

Estimated Taxes

For business owners who must make estimated tax payments, they are generally due on the following dates:

• 1st quarter payment deadline: April 15, 2024 (30%)
• 2nd quarter payment deadline: June 17, 2024 (40%)
• 3rd quarter payment deadline: September 15, 2023 (0%)
• 4th quarter payment deadline: January 15, 2025 (30%)

See the extension for businesses impacted by disasters below.

General Partnership 

Return Due Date: 15th day of the 3rd month after the close of tax year

Extended Filing Due Date: 15th day of the 10th month after the close of tax year

Annual Tax: Not required

Annual Fee: Not required

Limited Partnership (LP)

Return Due Date: 15th day of the 3rd month after the close of tax year

Extended Filing Due Date: 15th day of the 10th month after the close of tax year

Annual Tax: 15th day of the 3rd month after the close of your tax year.

Annual Fee: Not required

Limited Liability Partnership (LLP)

Return Due Date: 15th day of the 3rd month after the close of tax year

Extended Filing Due Date: 15th day of the 10th month after the close of tax year

Annual Tax: 15th day of the 3rd month after the close of your tax year.

Annual Fee: Not required

Limited Liability Limited Partnership (LLLP) 

Return Due Date: 15th day of the 3rd month after the close of tax year

Extended Filing Due Date: 15th day of the 10th month after the close of tax year

Annual Tax: 15th day of the 3rd month after the close of your tax year.

Annual Fee: Not required

Series Limited Liability Company (SLLC)

Return Due Date: 15th day of the 3rd month after the close of tax year

Extended Filing Due Date: 15th day of the 10th month after the close of tax year

Annual Tax: 15th day of the 4th month after the close of your tax year

Annual Fee: 15th day of the3rd month after the close of your tax year

LLC Classified as a Partnership

Return Due Date: 15th day of the 3rd month after the close of tax year

Extended Filing Due Date: 15th day of the 10th month after the close of tax year

Annual Tax: 15th day of the 4th month after the close of your tax year

Annual Fee: 15th day of the 3rd month after the close of your tax year

Single Member LLC

Return Due Date: 15th day of the 3rd month after the close of tax year

Extended Filing Due Date: 15th day of the 9th month after the close of tax year

Annual Tax: 15th day of the 4th month after the close of your tax year

Annual Fee: 15th day of the 3rd month after the close of your tax year

Single Member LLC

(Owned by an individual or pass-through entity) 

Return Due Date: 15th day of the 4th month after the close of tax year

Extended Filing Due Date: 15th day of the 10th month after the close of tax year

Annual Tax: 15th day of the 4th month after the close of your tax year

Annual Fee: 15th day of the 4th month after the close of your tax year

S Corporation

Return Due Date: 15th day of the 3rd month after the close of tax year

Extended Filing Due Date: 15th day of the 9th month after the close of tax year

Annual Tax: 15th day of the 3rd month after the close of your tax year

Annual Fee: Not required

C Corporation

C Corporation Short Year: See instructions

Return Due Date: 15th day of the 4th month after the close of tax year

Extended Filing Due Date: 15th day of the 11th month after the close of tax year

Annual Tax: 15th day of the 4th month after the close of your tax year

Annual Fee: Not required

Emergency Tax Relief

Businesses and individuals and businesses impacted by the San Diego County floods qualify for an extension to pay their April estimated tax payment. The deadline for payments due April 15, 2024, has been extended to June 17, 2024.