Start an S Corporation in California

Most California small business owners want to save on operating costs wherever possible. This is where starting an S corporation comes into play. By starting an S corp in the Golden State, you can reduce how much you pay the Internal Revenue Service (IRS) in federal taxes. 

This step-by-step guide shows you how to start an S corp in California, the unique benefits of this tax designation, and the eligibility requirements needed to elect the status.

S Corporation in California: Key Points

• An S corporation is a tax designation that reduces self-employment tax.

• California S corporations avoid double taxation on the federal level but pay state income tax on corporate and personal tax returns.

• All California S corporations must pay the annual franchise tax, but the fee is waived during the first year for newly formed corporations.

What is an S Corporation?

S corp status does not refer to a formal business entity. An S corporation is a C corporation or limited liability company (LLC) that elects the tax designation under IRS tax code Subchapter S. Eligible California businesses that choose S corp status benefit from federal self-employment tax savings.

Tax Considerations for an S Corporation in California

California companies can elect S corp status to get a reduction in federal self-employment tax. With S corporation tax treatment, shareholders avoid double taxation by only paying federal income tax on their individual tax returns.

It’s essential to note that all California companies must pay state income taxes at corporate and individual levels, regardless of their tax status. An S corporation’s net income is taxed at 1.5 percent in California. Shareholders also pay state income tax on their share of the income. 

California Tax Treatment of S Corporations

S corporation status can lead to a reduction in self-employment tax at the federal level. If you own an LLC or C corporation, you can elect S corp designation in California by filing IRS Form 2553.[1]

California Franchise Tax for S Corporations

According to the State of California Franchise Tax Board, California S corporations must pay a minimum annual franchise tax of $800.[2] The state waives the franchise tax during the first year of newly formed S corporations or if an S corporation did not conduct any business in California that tax year. 

The franchise tax is due annually in the first quarter of the accounting period. Businesses must file a California S Corporation Franchise or Income Tax Return (Form 100S) along with payment.[3]

Pass-Through Taxation

An S corporation in California is a pass-through entity, meaning income, deductions, losses, and credits go to the company’s shareholders. Each shareholder reports income and losses on their personal tax return, resulting in less federal tax. Shareholders also benefit from paying taxes at the individual rate, usually lower than the corporate tax rate.

Requirements for Forming an S Corporation in California

It’s essential to check that your LLC or corporation is eligible for S corp status. Certain business types, such as insurance companies, credit unions, and banks, do not qualify for this tax designation. Businesses that get most of their revenue from exports are also not eligible.

All S corporation shareholders become employees once a business is granted S corp status. You must run payroll, pay a reasonable salary, and open a separate business bank account.

Your company must also meet the following IRS requirements for S corporations:[4]

• Be an eligible domestic LLC or corporation

• Have a particular type of shareholder (individuals, estates, and certain trusts) that are US citizens or resident aliens

• Have no more than 100 shareholders

• Have only one class of stock

How to File as an S Corp in California in 7 Steps

You must create an LLC or C corporation before filing as an S corporation in California. To help you get started, here are the seven steps to form a business and gain S corp status.

Step 1: Choose a Business Name

Your first step in forming an S corporation in California is choosing a business name carefully. You’ll want to select a name that is easily understood and searchable by potential clients. It should also describe or relate to your products or services. 

Here are additional rules for naming a business in California:[5]

• Must include the phrase “limited liability company,” “LLC,” or “L.L.C.”

• Must be distinguishable from other company names in the California Secretary of State database⁵

• May not falsely imply government affiliation

• It may not falsely imply that the company is an insurer

Once you have the perfect business name, it’s essential to double-check that another company isn’t using it in California before you reserve it. We offer a free business name search to complete this step in minutes, or you can search the California Secretary of State website. 

It’s also advisable to consider trademarking your business name. A registered trademark prevents competitors from performing business in your name or imitating your brand. You can file for a federal name trademark with the United States Patent and Trademark Office (USPTO) to gain nationwide brand protection.[6] You can also get a state trademark through the California Secretary of State website.[7]

Step 2: Appoint Directors and a Registered Agent

S corporations must appoint a board of directors who oversee the company. Additionally, S corps can have up to 100 shareholders who get cash or dividends from company profits.

California law also requires all businesses to appoint a registered agent. This role is fulfilled by a company or individual authorized to receive official and legal correspondence on behalf of your business. 

Whoever serves as your California registered agent must have a California physical address on the public record and be present Monday through Friday from 9 am to 5 pm. Because of these privacy drawbacks, many business owners find hiring an outside registered agent service is the best and easiest course of action.

Looking for the best registered agent service? We can file your S corp paperwork and fulfill your registered agent requirements quickly and easily.

Step 3: File Articles of Organization

The Articles of Organization officially register your business with the California Secretary of State.[8] Also known as the Certificate of Formation, it requires the following information:

• LLC company name

• Principal business address

• Registered agent name, address, and signature

• Manager(s)

• Purpose of LLC

• Organizer signature

The Articles of Organization filing fee is $70, but the California Secretary of State has waived this fee until June 30, 2023. Please note that all LLCs in California must also file an annual report and pay the annual franchise tax of $800.

Step 4: File Statement of Information

You must file a Statement of Information within 90 days of filing for your LLC. This document validates your contact information with the California Secretary of State. You can file with the California Business Programs Division with a $20 filing fee.[9]

In the Statement of Information, you must provide the following:

• Company name

• Employer identification number (EIN)

• Business address

• Manager name and contact information

• Registered agent name and contact information

• Business type

• CEO’s name and contact information, if applicable

• Signature

Your Statement of Information is due every two years by your LLC’s approval anniversary date. You can file up to five months before your anniversary month, but you face a $250 penalty if you miss the deadline. We’ll automatically handle all your compliance filings on your behalf with your LLC formation order. 

Step 5: Attend to Additional LLC Requirements

According to the California Department of Tax and Fee Administration, you must obtain a seller’s permit if you “intend to sell or lease tangible property that would ordinarily be subject to sales tax when sold at retail.”[10] All California businesses also require a city or county business license.

Additionally, suppose you operate under a fictitious name or one different from your legal name. In that case, you must also file for a DBA, which stands for Doing Business As. You must file for a DBA with your county Registrar-Recorder or Clerk’s office within 40 days of starting your business. 

Within 30 days of your DBA filing, you must publish a statement regarding the DBA in a locally approved publication four weeks in a row. The publisher will then file the required affidavit of publication with the clerk or recorder. DBA publication fees generally range from $20-100, and you must refile every five years. 

The California LLC process can be confusing, but we make it easy by completing all the filing and paperwork legwork on your behalf. All you have to do is fill out a short questionnaire, and we’ll handle the rest while you focus on your business.

Step 6: Create an S Corp Operating Agreement

Unlike most states, California requires all LLCs to keep an S Corp Operating Agreement in their official records. This document outlines the LLC ownership structure, including the business owners, company bylaws, and member responsibilities. The agreement is legally binding once all members sign the document.

You should include the following in your Operating Agreement:

• Company name

• Effective date

• Member names and addresses

• Registered agent name and address

• Company purpose

• Member contributions

• Ownership interest and distribution plan for profits and losses

• Process for admitting new members or electing managers

• Dissolution process

Step 7: Apply for an Employer Identification Number

You must obtain an Employer Identification Number (EIN) from the IRS before opening a bank account, getting a company credit card, and, more importantly, electing S corp status. 

EINs provide the IRS with a means of identifying and tracking businesses regarding employment and income tax. They’re essentially your business’s social security number.

You can apply for an EIN on the IRS website, or we can obtain an EIN for you without charge.[11]

Step 8: File Form 2553 for S Corporation Election

The final and most crucial step is to elect S corp status for your business entity with IRS form 2553.[12]

Form 2553 requires the following information:

• Company EIN

• Incorporation date

• State of incorporation

• S corp election date

• Selected tax year

• Indication of whether family members are shareholders

• Shareholders’ names and addresses

• Shareholders’ stock percentage

• Selected fiscal year

• Signatures

You must elect S corp status within one of the following periods:

• Within 75 days of forming an LLC or C corporation

• Anytime in the year before the tax year of the S corporation election

• No more than 75 days after the beginning of the selected tax year

If you miss the filing deadline for form 2553, you must also file Form 8832, Entity Classification Election, to be taxed as an S corporation.[13]

California S Corp vs. California LLC

There are benefits and drawbacks to S corp tax treatment. Some business owners might find that sticking with their LLC works better for their tax goals. That’s why it’s essential to consider the pros and cons of LLCs and S corps for your business.

Advantages of Starting an LLC in California

California LLCs are easy to set up and maintain. This business structure also protects personal assets by separating your business entity and private property. If you don’t use personal assets as collateral to fund company debt, your money and belongings can’t be seized.

Starting an LLC in California allows you to enjoy pass-through taxation. Federal income taxes pass through to your personal tax return, meaning you pay a lower income tax rate. This method also prevents double taxation on the corporate and individual levels.

If the ins and outs of starting an LLC seem overwhelming and time-consuming, we’ll take the hassle out of your hands to make the process quick and easy.

Disadvantages of Starting an LLC in California

California LLCs are more expensive compared to sole proprietorships. You must pay $70 to file your Articles of Incorporation and $20 for your Statement of Information. California LLCs are also responsible for the $800 annual franchise tax fee.

All California LLCs must be registered with the California Department of Tax and Fee Administration to pay taxes on all products sold. The statewide sales tax rate is currently 7.25%, but it is considerably higher in some major cities.

Advantages of forming an S Corporation in California

Like LLCs, S corporations in California offer personal asset protection, but their main benefit is tax savings. 

In addition to benefiting from pass-through taxation, S corp owners pay federal self-employment and personal income tax on a reasonable salary rather than the entire amount. Any remaining profits are allocated to each shareholder and are not subject to self-employment tax. This results in significant tax savings.

Disadvantages of forming an S Corporation in California

S corporations in California avoid double taxation at the federal level. However, they are still taxed twice at the state level. The net income is taxed at 1.5% at the corporate level, then passes through to the shareholders’ tax returns and is taxed at the state level.

S corporations are limited to 100 shareholders and only one class of stock, so it might not be the best classification for businesses predicting rapid growth. All shareholders must be U.S. citizens, resident aliens, or certain estates and trusts, preventing international partners.

Business owners should consider the additional administrative costs of owning an S corp, including running payroll. It’s also essential to note that the IRS watches companies with S corp designation more closely because of the tax benefits. This could mean a higher chance of a tax audit.

Get the Legal Benefits of an LLC with the Tax Benefits of an S Corp

An S corporation combines the personal asset protection of an LLC with additional tax advantages. With its pass-through taxation and reduced self-employment tax benefits, you can save a lot of money.

Ready to File for S Corp Status in California?

If you’d like to ensure you file for S corp status correctly, we can help. Our expert business formation specialists will answer questions about S corp limitations and benefits, then set up your S corporation in California with quick and seamless assistance.

Frequently Asked Questions

What is an S Corporation in California?

An S Corporation is an IRS tax election, not a formal business entity. Eligible California businesses can elect this tax status to enjoy pass-through taxation on the federal level. Income and losses flow through to the shareholder’s individual tax returns, and they pay federal taxes on a reasonable salary. The result is a reduced self-employment tax.

Does California recognize S corporations?

Yes, California recognizes S corporations that remain in good standing.

What is the turnaround time for filing for S corp status with the IRS?

A company should receive notice from the IRS on whether their S corp election is approved 60 days after filing Form 2553.

What is the difference between an S corp and an LLC?

LLCs and S corporations offer pass-through taxation, but S corporations also provide additional savings. S corp managers and owners pay self-employment and personal income tax on a reasonable salary. When the remaining profits are withdrawn as a distribution, the recipient doesn’t have to pay more self-employment tax on the amount.

What are the requirements for an S corporation in California?

A business must meet the following requirements to qualify as an S corporation in California: 

• Be an eligible domestic LLC or corporation

• Have a particular type of shareholder (individuals, estates, and certain trusts.) that are US citizens or resident aliens.

• Have no more than 100 shareholders

• Have only one class of stock

Are taxes for LLCs and S corps the same?

While both business types offer pass-through taxation, the taxes for LLCs and S corps differ. LLC owners pay self-employment and personal income tax on the total amount earned. In contrast, S corporation owners only pay tax on a “reasonable salary.” Any remaining profits in shareholder distributions are not taxed.

What is the S corp tax rate?

The S corporation tax rate depends on shareholder personal tax rates, which currently fall between 10% to 37%.[14]

How do I dissolve an S corporation in California?

You can dissolve an S corp in California with the Secretary of State and the Franchise Tax Board.[15]

You must file delinquent tax returns and pay outstanding balances, penalties, or interest with the Federal Tax Board. Then, you must also file either a dissolution, surrender, or cancellation form(s) with the California Secretary of State within 12 months of filing your final tax return.

Once you dissolve the company, you must stop doing business in California after the final taxable year.

Bibliography

1. Internal Revenue Service. “About Form 2553, Election by a Small Business Corporation.”  Accessed January 4, 2023.

2. State of California Franchise Tax Board. “S corporations.” Accessed January 4, 2023.

3. State of California Franchise Tax Board. “California S Corporation Franchise or Income Tax Return - Form 100S.” Accessed January 4, 2023. 

4. Internal Revenue Service. “S Corporations.” Accessed January 5, 2023.

5. California Secretary of State. “California Code of Regulations.” Accessed January 5, 2023.

6. United States Patent and Trademark Office. “Trademark basics.” Accessed January 5, 2023.

7. California Secretary of State. “Trademarks and Service Marks.” Accessed January 6, 2023.

8. California Secretary of State. “Secretary of State Articles of Organization.”    Accessed January 9, 2023.

9. California Secretary of State. “Form LLC-12.” Accessed January 10, 2023.

10. California Department of Tax and Fee Administration. “Obtaining a Seller’s Permit.” Accessed January 10, 2023.

11. Internal Revenue Service. “Apply for an Employer Identification Number (EIN) Online.” Accessed January 10, 2023.

12. Internal Revenue Service. “Form 2553.” Accessed January 10, 2022.

13. Internal Revenue Service. “Form 8832.” Accessed January 10, 2022.

14. Internal Revenue Service. “IRS provides tax inflation adjustments for tax year 2022.” Accessed January 10, 2023.

15. California Franchise Tax Board, “Guide to Dissolve, Surrender, or Cancel a California Business Entity.” Accessed January 10, 2023.