Note: California has temporarily waived the filing fees (with the exception of a required $5 certified copy fee) for most business formations, including corporations and LLCs. You’ll need to file before June 30, 2023, to take advantage of this free filing.
Are you considering setting up an S corp in California? “S corp” refers an S corporation, which is a tax filing status for an LLC or a corporation, one with the potential to lower your tax bill. This article will show you how to create an S corp in California, including the unique aspects of doing so in the Golden State.
For a limited liability company (LLC), filing as an S corp may provide savings on self-employment taxes in some cases. For C corporations (C corps), it can be a way to avoid double taxation on federal income taxes. For more information about S corps, see our “What Is an S Corporation?” page.
You should understand that an S corp is not a business structure. Rather, it’s a tax classification that either an LLC or a corporation can apply for with the IRS if it meets the criteria. We’ll outline those criteria and the steps you would need to take to file as an S corp if you decide that it’s right for your business.
If you want to form an LLC with S corp status, our S corp service can help you do just that. Plus, we offer other services to help you run and grow your business and stay in compliance with federal and California laws.
Before you form an S corp in California, you need to be aware of the S corp filing requirements and limitations. Specifically, to qualify for S corporation status, an entity must:
Not all business entities are eligible for S corp classification. However, if your business entity meets these requirements, you can apply for an S corp election.
When an LLC or C corp elects to be taxed as an S corp for federal income tax purposes, most states apply state income tax in the same way. In other words, the business doesn’t pay federal or state income tax at the business level, just the individual level.
California is different, though. An S corp pays state income taxes at both the business and individual levels. Here are some other differences for S corps in California:
To have a California S corporation, you’ll need to create either a limited liability company (LLC) or a C corporation (the default form of corporation) if you haven’t already done so. Then, you’ll file an election form with the Internal Revenue Service (IRS).
If you’re ready to learn about filing as an S corporation in California, we’ll walk you through it. First, we’ll show you how to form an LLC in California. If you’d rather form a California corporation, follow the instructions on our California corporation page. Then, in Step 7, we’ll explain how to file for S corp status as either an LLC or corporation.
Pick a name for your California company. You must find a name that’s not in use by any other California business. Our California business search page can help you with that.
If you find that your name is available but you’re not yet ready to file Articles of Organization with the state of California, you can reserve it.
Read up on the state’s naming guidelines to ensure you’re following all the rules. A few of the general guidelines include avoiding profanities, names that could mislead the public, and anything that makes your company sound like a government agency or entity (like “police,” “county,” and “state”).
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Appoint a California agent for service of process. Called a “registered agent” in most states, this is a person or business that receives important legal notices (such as subpoenas) on behalf of your company. They’re required to be available during all business hours so that they can accept notices in person. We can help you find a California agent for service of process.
Next, you need to file your California Articles of Organization. This form explains things such as who’s involved in your LLC and their contact information. Articles of Organization are required for every LLC in the state of California. Fortunately, we specialize in handling this kind of paperwork with our business formation plans. We can take care of this step for you and make sure it’s done correctly the first time.
Unlike many other states, California requires two separate forms to be filed in order to form your LLC. First, there are the aforementioned Articles of Organization. Next, is the Statement of Information (which we’ll cover next).
Submit your California Statement of Information. This is the second part of the initial paperwork for starting your LLC in the Golden State. Remember, this step is in addition to filing the Articles of Organization.
Your Statement of Information has to be filed within 90 days of formation to retain your LLC name and status with the state.
Make a California operating agreement for your LLC. Operating agreements outline the rules and operating procedures for the management of the LLC, much like the bylaws required by corporations. They also include information such as how the ownership and profits are divided among the members. Most states do not require LLC operating agreements, but California does. Not sure how to create an operating agreement for your California Limited Liability Company? We offer an operating agreement template to help you get started.
Get an Employer Identification Number (EIN). This is the tax ID number for your LLC. This number is also commonly referred to as a Federal Employer Identification Number (FEIN).
Your EIN identifies your company to the Internal Revenue Service (IRS) much like your Social Security number identifies you with the federal government. Just as you use your Social Security Number to file personal taxes, you’ll use your EIN to file business taxes.
Submit the form to apply for S corp status. Once your LLC or C corporation formation is approved by the state, you need to file Form 2553, Election by a Small Business Corporation, to get S corp status.
The IRS requires that you complete and file your Form 2553 with the IRS:
One caveat for LLCs wishing to file as an S corp: If your LLC is past the 75-day election deadline, you’ll also need to file Form 8832, Entity Classification Election, to elect to be taxed as a corporation. Then you would file both Form 8832 and Form 2553 together via USPS-certified mail.
For more information on when and how to file Form 2553, visit the IRS website.
While S corp classification does come with a number of tax benefits for some businesses, making this election might not be right for all business types. So, be sure to carefully weigh the various pros and cons before deciding how you want to move forward. Consult a tax professional about whether the S corp election would be best for your business.
The advantages of filing as an S corp for an LLC aren’t exactly the same as they are for C corporations. Let’s look at the advantages for limited liability companies first.
A traditional LLC already has pass-through taxation for federal income tax, although California does not have pass-through taxation for state income tax for S corps. So, that’s one less benefit that having an S corp would have in most states.
The benefits of S corp election for an LLC have to do with self-employment tax. This takes some explanation, but for certain LLCs, it could save a lot in taxes.
The members of a standard LLC are considered self-employed. They’re compensated by receiving their share of profits from the LLC, but they can’t be employed by the LLC. Being self-employed means paying self-employment tax (Social Security and Medicare, which adds up to about 15.3%) on all profits they receive from the LLC. This is more than the taxes they’d pay when working for someone else because their employer would pay part of them.
But when the members elect S corp status, they can be compensated in two ways, by receiving their share of the profits and by being paid as an employee. Once they do that, they only pay Social Security and Medicare taxes on their salary and not the profits they receive. Depending on factors such as how profitable your company is, the savings could add up to a lot. (Of course, the members will still pay income and all other applicable taxes on their share of the profits.) Money paid out as salary is a tax-deductible expense for the business.
One caveat to this is that the IRS expects you to pay yourself a “reasonable salary” as an employee of the LLC. Otherwise, you could pay yourself an annual salary of $1 and avoid contributing anything to Social Security and Medicare.
Having an LLC with S corp status can have some drawbacks over a traditional LLC:
As we listed above, S corps must adhere to more regulations than a standard LLC or C corporation. An S corp can have no more than 100 members, and none of them can be partnerships, corporations, or non-resident aliens. A traditional LLC doesn’t have these limitations.
Because of the above restrictions and the requirements about paying yourself a “reasonable salary,” the IRS tends to monitor LLCs filing as S corps more closely. That could mean a greater chance of being audited, even if you follow the law to the letter. In fact, S corp owners may want to observe many of the same formalities that C corporations do (such as regular meetings and extensive record keeping), even if they’re not legally required to.
Having an LLC that files as an S corporation generally means more paperwork. If you don’t already have to do payroll for your business, being an owner-employee means that you’ll have to do so. Your taxes will be more complex, as well.
With these added complications, you’re likely to have higher administrative costs. You may find that you need an accountant, bookkeeper, and/or a payroll service or software.
If you have a C corporation (the default form of corporation), filing as an S corp does have its advantages:
One big disadvantage for traditional corporations is “double taxation.” When the corporation makes money, the IRS taxes those profits on the corporate level. But when those profits are distributed to the individual business owner (shareholder) as dividends, they’re taxed a second time on the shareholder’s personal tax return.
But when a C corporation qualifies to be an S corp, those profits are only federally taxed at the individual level. The business itself doesn’t pay income tax on them. This is called “pass-through taxation,” and it’s how sole proprietorships and general partnerships are taxed.
As mentioned earlier, in California, pass-through taxation for an S corp applies only to federal income taxes, not state income taxes. Your business still must pay state income taxes at both the corporate and shareholder levels.
We need to add here that, since the 2017 Tax Cuts and Jobs Act, the corporate tax rate has been lowered to a flat 21%. So, the disadvantages of double taxation aren’t as severe now as they were.
Just as business profits pass through to the owners of an S corp, so do the losses. Unlike the shareholders of a C corporation, S corp owners can write off the company’s losses on their personal income statements.
This can help offset their income from other sources and can be helpful if the corporation loses money in the first couple of years. Still, make sure you’re aware of the IRS’s shareholder loss limitations.
Under the Tax Cuts and Jobs Act, some S corp owners may be able to deduct up to 20% of their qualified business income. This deduction isn’t available to C corporation shareholders.
Qualified business income (QBI) is basically your share of the company’s profits, or, as the IRS puts it, “QBI is the net amount of qualified items of income, gain, deduction and loss from any qualified trade or business, including income from partnerships, S corporations, sole proprietorships, and certain trusts.” The IRS website has a detailed explanation as to what is and is not included in QBI. There’s an income threshold that, if exceeded, may reduce your QBI (see the IRS website for details).
S corp status also has its downsides:
As we said, an S corp can’t have more than 100 shareholders, while a C corporation has no such restriction. That limitation could be an issue later if the corporation expands and goes public.
All S corp shareholders must be U.S. citizens, or certain trusts or estates. That could limit your ability to expand internationally. You also can’t have partnerships or corporations as shareholders. C corporations don’t have these limitations.
One way corporations attract investors is to offer preferred stock. That’s fine for C corporations, but the IRS doesn’t allow it for S corps.
Because of the extra restrictions S corps have, the IRS watches them more closely to see if they’re in compliance. In other words, your corporation is more likely to get audited.
We can’t stress enough how important it is to have tax guidance about your specific situation from a qualified tax professional. An accountant with S corp experience should be able to make sure you stay in compliance with the IRS, but they may also be able to help you find additional tax savings.
Forming a business can be complicated, but we’re here to make it as easy for you as possible.
When you’re ready to take the leap, we can help you form a California LLC with an S corporation designation and provide you with valuable support for all of your business needs moving forward. Click the button below to get started.
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An S corp is not a business structure. It’s a tax classification that either an LLC or a corporation can apply for with the IRS if it meets the criteria. For a corporation, S corporation election allows the corporation to avoid double taxation on federal income.
For an LLC, S corp status has the potential to save the members on federal self-employment tax (Social Security and Medicare).
Unlike most states, California taxes S corporation profits at both the business level and individual shareholder levels when it comes to state income taxes.
As we mentioned earlier, California is unusual because it doesn’t treat S corporation income the same way the federal government does.
An S corp in California pays state income taxes at both the business and individual levels.
For other differences in how California treats S corporations, see the S Corp in California Considerations section.
For a corporation, one of the biggest advantages is being able to avoid double taxation on the business’s income at both the entity and individual levels, thereby benefiting from pass-through taxation.
For an LLC, when the members elect S corp status, they can be compensated in two ways, by receiving their share of the profits and by being paid as an employee.
Once they do that, they only pay employment taxes (Social Security and Medicare) on their salary and not the profits they receive (other taxes still apply). For some limited liability companies, this can add up to savings on self-employment taxes.
Before formally registering a business name, you should first search the California business entity records to make sure that you don’t select one that’s already in use by another business.
That aside, however, you can typically name your California S corporation nearly anything you want as long as you comply with any applicable state naming regulations.
S corp status may not be right for all businesses. If you’re not sure whether to identify your LLC as an S corp or keep the default status, be sure to consult with an experienced business law attorney or accountant in your state.
Calculating taxes can be confusing, but you can check out our S corp tax guide to learn more about navigating taxes for your California S corporation. A certified tax professional can give you more definitive information for your circumstances..
Sorry, but our S corp service is only for applying for S corp status when you form your LLC with us.
According to the IRS website, you’ll be notified of whether or not your S corp election is accepted within 60 days of filing Form 2553.
If you’re a new LLC, you must apply for S corp status within 75 days of the formation of your LLC or no more than 75 days after the beginning of the tax year in which the election is to take effect.
For an existing business, you would file at any time during the tax year preceding the tax year it is to take effect.
An LLC is a legal business entity, whereas an S corp is a tax filing status with the IRS. You can learn more about the similarities and differences between LLC’s and S Corps.
For more state-specific information on the differences between California LLCs and S corporations, see our LLC vs. S Corp in California page.
An LLC is a business type, while S Corp is a tax filing. Learn more about the differences and compare California LLCs vs. S Corps.
Disclaimer: The content on this page is for information purposes only, and does not constitute legal, tax, or accounting advice. If you have specific questions about any of these topics, seek the counsel of a licensed professional.
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