It's Time to Repeal the Business Start-Up Tax

by Tony Miller
Acting Secretary of State

Job creation must be our highest priority in California. We must
search and destroy the job-killers wherever we can find them. Repealing
the new business start-up tax is a place to start.

Most new businesses consider incorporation in order to shield
personal assets and to establish credibility. Currently, to incorporate
in California, a business must file articles of incorporation with the
secretary of state and must pay a filing fee of $100. In addition, a
business must pay the secretary of state $800, which is transmitted to
the Franchise Tax Board.

That $800 must be submitted at the time of incorporation, yet it is
not a prepayment of the first year's minimum tax. The corporation is liable
for the minimum tax for the first and subsequent years without regard to
the $800 prepayment. The prepayment is credited to the corporation's tax
liability only should the corporation dissolve or otherwise be terminated.

The $800 prepayment is, in reality, a start-up tax for the
"privilege" of incorporating a business. As such, it is a job-killer
since it discourages the creation of businesses in California by adding a
significant cost when cash flow is typically the most challenging.

The impact can be particularly dramatic during the first critical
year of a new business. Suppose a business incorporated in November of
1993 and files tax returns on a calendar year basis. The corporation
earns no income during 1993. Gotcha. The corporation will not only have
to prepay the $800 at the time of incorporation, it will be liable for
another $800 minimum tax for the tax year 1993. That tax must be paid
early in 1994. Sixteen-hundred dollars is a lot of money for businesses
just getting started and already burdened with the other costs of licenses,
supplies, inventories, telephones and so on.

The new business start-up tax is not new. However, as recently as
1986, it was only $200. The Legislature increased it to $300 in 1987, to
$600 in 1989 and to $800 in 1990. Along with these substantial
increases, the number of new corporate filings has decreased from 69,000
in fiscal year 1986-87 to 49,877 in 1992-93. While not all of that
decrease can be attributed to the increases in the new business start-up
tax, based on client comments and correspondence, the increase
in the tax is a significant factor. The operation of the tax and its
increases have certainly contributed to the perception that California is
hostile to business.

The new business start-up tax doesn't just have an impact on
entrepreneurs. It also discourages and delays the formation of nonprofit
corporations. That's because the articles of incorporation for a
nonprofit organization cannot be filed until either the $800 prepayment
is made or an exemption has been obtained from the Franchise Tax Board.

Since obtaining a nonprofit tax exemption from the Franchise Tax Board
ordinarily takes weeks, those nonprofit organizations wanting to incorporate
immediately must first find $800. Thus, for those organizations having
an urgent mission that cannot wait for the tax exemption application to be
processed-the Polly Klass Foundation was a case in point-the $800 must be
paid up-front. The $800 is refunded six months or so after the exemption
is granted by the Franchise Tax Board. Organizations not having the $800
or the time to wait are simply out of luck.

Certainly, the current new business start-up tax does generate some
immediate revenue for the state. With 3,000 or so businesses
incorporating in California every month, it amounts to some $29 million a
year flowing into the state's general fund.

However, much more than that would be gained if this disincentive to
incorporating in California were to be removed. The number of incorporations
would increase with the elimination of the tax. That would mean
additional tax revenue. The more corporations in existence, the more
taxes paid. More significantly, the additional new businesses would
create jobs and foster economic growth that would, in turn, generate
substantial additional tax revenue.

In his State of the State address earlier this year, Governor Wilson
noted that we must help small businesses since the vast majority of new
jobs in California will come from that sector. He went on to call for
incentives for those risk-takers willing to start a business. He was
right. Small businesses are the backbone of our economy and eliminating
the new business start-up tax is bound to create jobs. Let's do it. Now.


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