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Once you have your business, you’re going to need to choose a tax structure, and you may have a number of questions. An S Corporation is a type of tax structure that has the potential to help you save on your taxes. This article will help you understand more about how to form an S Corp in California. An important distinction is that S corporation is not a standalone business entity type, like an LLC or C corporation. In fact, it is a special tax status recognized by the Internal Revenue Service. The S corp status exempts a business entity from business income tax. Instead, its business profits get passed through onto the shareholders or members who then individually file their personal income tax return and pay income tax.
The first step to forming a California S Corp is to officially form your business with the Secretary of State. LLCs and corporations each have their own set of steps to make sure the process is completed correctly.
California corporations are comprised of stockholders and have the ability to raise capital by issuing stock. These business entities have a more formal management structure than limited liability companies requiring regular meetings and specific documentation and record-keeping. Forming a corporation may seem like a lengthy process, but we have tools and resources to help simplify these steps.
For some business owners setting up a California LLC with an S Corporation status may have a set of benefits as opposed to forming a corporation. A limited liability company has a simple management structure that does not require formal meetings. LLCs are made up of members and can transfer or distribute according to the company operating agreement. Forming an LLC is common for many small businesses because it is simple to set up and maintain. The type of business you operate, along with size and scope, are important factors when deciding on your business structure.
Adhere to all California state naming requirements and limitations for your corporation or limited liability company. Business names should reflect the personality of the company while ensuring the purpose is clear.
A registered agent is someone who receives all business and legal correspondence for your company. They are required to be available during all business hours. It is best to not have this person be you, because you may want to make a coffee run or go on a vacation. We can help you choose your California registered agent.
Your corporate board of directors or LLC members and managers are responsible for most major decisions regarding business operations. Limited liability companies have managers/members and corporations have directors. These roles must be designated on the forms you file to complete formation. The designations can be changed later on.
Articles of Incorporation and Articles of Organization are the formative documents for corporations and LLCs, respectively.
Filing Form 2553 with the IRS will be your final step to complete your business filings and elect S Corporation tax structure. Complete the final business requirements to file an S Corp in California after you have obtained your Employer Identification Number (EIN), because it will be needed for the form. LLCs will need to file form 8832 before form 2553.
Prior to choosing your business’s tax structure, it’s a good idea to understand the requirements and limitations of a California S Corp according to the IRS.
The corporation cannot be ineligible, which includes certain financial institutions, insurance companies, and domestic international sales corporations.
There are several reasons to choose or not choose to elect S Corporation tax status. It’s often a good idea to check with a tax professional if you’re not sure what is best for your specific business. Here are some things to consider.
The most notable benefit of electing to file as an S Corporation is pass-through taxation at the federal level. In most states, S Corps aren’t taxed at all at the corporate level. However, according to the California tax service center, a California S Corp must pay either 1.5% of the company’s net income or $800 annually, whichever number is greater.
Aside from federal pass-through taxation, another benefit in California is that businesses can save money by paying shareholders or members a reasonable salary and then classifying the remaining profits as distributions. Distributions are typically taxed at a lower rate than self-employment taxes.
California S Corporations are required to pay a state Franchise Tax and to adhere to formal administrative standards. S Corporations may be subject to increased scrutiny by the IRS. If an S Corp is underpaying shareholders or members for the purpose of allocating higher distributions to be taxed at a lower rate, the IRS can reclassify the distributions as wages. This means the business will owe more money to the IRS.
Other California S Corporation requirements state that the business can have both voting and non-voting shares but can have one class of stock and no more than 100 shareholders.
In most states, there are significant differences between S and C Corps, the primary difference being pass-through taxation. S Corps in many states pass taxes onto the personal tax returns of their members or shareholders, bypassing corporate taxation. While California S Corps enjoy pass-through taxation on their federal taxes, both S and C Corporations pay California taxes at the corporate level. Taxes are also paid by owners and employees on whatever income is received from the business. This is considered “double-taxation.”
There are differences between S Corporations and C Corporations regarding how income is taxed for salary vs distributions, and different amounts of flexibility in operating standards and requirements. Self-employed business owners may opt for classifying some of their income tax as distribution and some as salary, resulting in tax savings.
Upon initial formation, regardless of your business structure, C corporation is the default tax structure. A Form 2553 must be filed to change from the default.
An S corporation is a specific tax election that can be made by an LLC or corporation to achieve a desired method of taxation.
Limited liability companies and corporations can both choose the California S Corp election. The election must occur within 2 months and 15 days after the beginning of the tax year the election is to take effect, or at any time during the tax year preceding the tax year it is to take effect.
There are exceptions if you’re unable to file on time, but it’s much easier to make the election when you register your business. Learn more about LLCs and taxation on our Tax Information for Limited Liability Companies page
Starting your own business can be both exciting and stressful. We’re here to ease some of the stress so you can focus on the fun stuff. Whether you’re choosing to form a limited liability company (LLC) or corporation, we can get you started with our California LLC Formation Services and Corporation Formation Services and keep you going and growing with business tools and services designed to meet your needs. As the next step, we will help you set up your business entity as a California S corporation with the the Internal Revenue Service (IRS.)
Deciding to form an S Corporation is an important part of making sure your business is set up for maximum profitability. Choose a tax structure that fits your needs. If you’re in the process of forming your LLC, let us help you set up your S Corp at the same time and reduce the hassle.
We’re here to support you throughout the process from initial formation to ongoing compliance and maintenance. As a business owner, you have enough going on already. Let us help simplify things wherever we can.
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.
Businesses can save money by paying shareholders or members a reasonable salary and then classifying the remaining profits as distributions. Distributions are typically taxed at a lower rate than self-employment taxes.
Follow California state LLC or Corporation naming guidelines to ensure you meet all state requirements. Check to make sure no other business is already using that or a similar name.
Your tax structure doesn’t have to be identifiable. The important part is filing the proper paperwork with the IRS.
California S Corps must pay either 1.5% of the company’s net income or $800 annually, whichever number is greater. Speak to an accountant to determine how to handle personal income taxes on S Corp earnings.
The California Franchise Tax Board Fee imposed on all business entities in the state is due on the second and all subsequent taxable years after your California S corp formation.