4.4 Tax Obligations, Payroll & Business Filings

Tax Obligations, Payroll & Business Filings

Operating a contracting business in California entails compliance with state and federal tax authorities. Contractors must navigate California Franchise Tax Board (FTB) business filings, Employment Development Department (EDD) payroll tax rules, California Department of Tax and Fee Administration (CDTFA) sales and use tax regulations on materials, and strict worker classification standards under Assembly Bill 5 (AB 5) and California Labor Code.

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1. Franchise Tax Board (FTB) State Taxes

All formal business entities organized or doing business in California are subject to tax regulation by the Franchise Tax Board (FTB).

The $800 Minimum Annual Franchise Tax (CA Rev & Tax Code § 23153)

• Mandate: Corporations (C-Corp and S-Corp), LLCs, Limited Partnerships (LPs), and LLPs must pay an annual $800 minimum franchise tax to the FTB.
• First-Year Exemption Note: Corporations (and newly formed LLCs under temporary California relief provisions) may receive an exemption from the $800 minimum tax during their first taxable year, but must pay tax on net income.
• LLC Gross Receipts Fee: In addition to the $800 tax, LLCs earning $250,000 or more in total California gross receipts pay a sliding-scale annual LLC fee ranging from $900 (for revenue between $250k–$499k) up to $11,790 (for gross revenue of $5,000,000 or more).

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2. EDD Payroll Taxes & Employer Obligations

The Employment Development Department (EDD) collects state payroll taxes. California has four major payroll tax components:

State Payroll Tax Breakdown

Mandatory EDD Filings

• Quarterly Filings: Employers must submit Form DE-9 (Quarterly Contribution Return and Report of Wages) and Form DE-9C (Quarterly Contribution Return and Report of Wages - Continuation) by the end of the month following each calendar quarter.
• Federal Filings: In addition to EDD, employers file IRS Form 941 quarterly (FICA + federal income tax withholding) and IRS Form 940 annually (FUTA unemployment tax).

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3. CDTFA Sales & Use Tax Regulations (Regulation 1521)

The California Department of Tax and Fee Administration (CDTFA) (formerly part of the Board of Equalization / BOE) governs sales and use tax under Regulation 1521 (Construction Contractors).

Contractor as "Consumer" vs. "Retailer"

• Contractor as Consumer (General Rule): When a contractor furnishes and installs construction materials (lumber, concrete, piping, wiring, roofing shingles) into real property under a lump-sum, cost-plus, or time-and-materials contract, the contractor is legally considered the end consumer of the materials.

  • Tax Requirement: The contractor must pay sales tax to the supplier when purchasing materials. If materials are purchased without paying sales tax (e.g., from an out-of-state vendor), the contractor must remit Use Tax directly to the CDTFA.

• Contractor as Retailer (Fixtures & Machinery): If a contractor furnishes and installs fixtures (prefabricated items like air conditioning units, water heaters, plumbing fixtures, electrical panels) or machinery, the contractor acts as a retailer. Sales tax must be billed to the customer based on the retail selling price of the fixture.

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4. Worker Classification: 1099 Subcontractor vs. W-2 Employee

Misclassifying employees as 1099 independent contractors is heavily penalized under California law.

Assembly Bill 5 (AB 5) & Labor Code § 2775 (The ABC Test)

Under AB 5, a worker is presumed to be a W-2 employee unless the hiring entity proves all three conditions of the ABC Test:

• Prong A: The worker is free from control and direction in performing the work.
• Prong B: The worker performs work outside the usual course of the hiring entity's business.
• Prong C: The worker is customarily engaged in an independently established trade or business.

The Construction Challenge: A general contractor hiring an individual carpenter fails Prong B because carpentry is inside the usual course of a general contractor's business.

The Statutory Subcontractor Exemption (Labor Code § 2781)

To protect legitimate construction subcontracts, California Legislature enacted Labor Code Section 2781, exempting construction subcontracts from the ABC test if the subcontractor meets 7 strict criteria:

1. Must hold an active CSLB license appropriate for the trade.
2. Must maintain a separate business location.
3. Must be registered with the Department of Industrial Relations (DIR) if performing public works.
4. Must have a written contract specifying project details and payment rates.
5. Must maintain active Workers' Compensation insurance.
6. Must exercise control over work execution and schedule.
7. Must be customarily engaged in an independently established construction trade.

Willful Misclassification Penalties (Labor Code § 226.8): Civil penalties range from $5,000 to $15,000 per violation, and $10,000 to $25,000 per violation for a pattern of willful misclassification.

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5. Tax & Employment Recordkeeping Requirements

• Statutory Retention Period: California Labor Code and EDD regulations require employers to retain all employment, timecard, payroll, and tax records for at least 4 years.
• Record Contents: Must document employee names, SSNs, gross wages, itemized deductions, daily start/stop hours, meal break logs, and tax returns.