How to Start an S-Corporation in California (2024 Guide)

Start an S-Corporation in California

If you want to start an LLC in California, there are things that you should consider. California is the home to a thriving business community, making it an attractive location for entrepreneurs. One popular business structure is the S-Corporation, which offers several tax and operational advantages. This comprehensive guide will explore the process of starting an S-Corporation in California, including the costs, steps, advantages, and disadvantages associated with this business structure.

Webinarcare Editorial Team will help you gain knowledge through thorough research and market study. Before starting your S-corp, all the steps in this article must guide you.

What is an S-Corporation?

An S-Corporation is a type of corporation that elects to be taxed under Subchapter S of the Internal Revenue Code. This tax treatment allows S-Corporations to enjoy pass-through taxation, meaning the corporation’s income, deductions, and credits flow through to the shareholders, who report this information on their individual tax returns. This structure helps to avoid the double taxation experienced by C-Corporations.

An S corporation (S corp) is not a type of corporate entity, unlike a limited liability company (LLC) or other companies. It’s a tax classification that might result in significant financial savings for corporations and LLCs but in different ways. S-corp is similar to LLC, except that the IRS treats it as a corporation for tax purposes.

Limitations and Requirements of S-Corp

As you have decided to have an S-Corp structure for your business, you must know the limitations and requirements to qualify for S-Corp status. We have listed some important points to consider following for your reference-

  • Be a domestic corporation.
  • Not be an ineligible corporation, such as specific financial institutions, insurance providers, or domestic corporations engaged in overseas sales.
  • Have just one type of stock.
  • Have a maximum of 100 shareholders or members.
  • Have only permitted individuals, certain trusts, and estates as stockholders or members.

You can apply for an S-Corp in California if qualified for the limitations and requirements.

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How to Form an S-Corporation in California?

To create S-Corp in California, you must follow the below guidelines that include forming a business name, hiring a Agent for Service of Process, filing your Articles of Organization, creating an operating agreement, requesting an EIN, and filing a form 2553.

Step 1: Register a Business Name in California

After you have decided on the idea to start an S-Corp in California, deciding the name for your corporation is significant. Legal procedures should be taken into account when choosing your partnership name. Choose a business name that will enable you to develop a strong brand identity.

If you want to set up an S-Corp, there is a complete guide on California Business Name Search for a proper business name. Here are some guidelines you must follow while naming your S-corp.

  • Avoid profanities
  • The name should be available, and no other entity should have the same name in California.
  • Limit of restricted words that need a license in California
  • Do not use a business name that sounds like a government agency or entity (like “police,” “county,” and “state”)

Step 2: Hire a Agent for Service of Process

The next step in starting an S-corp in California is hiring a Agent for Service of Process, a person that accepts legal paperwork on behalf of your business. This person or business will receive important tax forms, legal documents (such as subpoenas), all notices of lawsuits, and other official government correspondence. Forming an LLC with an S-corp will be easier if you have Agent for Service of Process in California.

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Step 3: File For Articles of Organization

The Articles of Organization is an important document to start your limited liability company (LLC). California Articles of Organization is a simple document that contains the business name and address as well as the name and address of the person who received lawsuits on behalf of the organization. For the Articles of Organization to be filed in California Franchise Tax Board, you need to pay a filing fee of $70. In California, the filing fee of forming an LLC is $70.

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Step 4: Creating an Operating Agreement

After you have filed your Articles of Organization, the next step is to create an operating agreement in California. The operating agreement is essential and necessary since it will cover your corporation’s important documentation and rules. The operating agreements usually include the following:

  • Article I: Organization
  • Article II: Management and Voting
  • Article III: Capital Contributions
  • Article IV: Distributions
  • Article V: Membership Changes
  • Article VI: Dissolution

After creating the LLC operating agreement, you can benefit in several ways since it will discuss how decisions for the business will be made, including management and member voting structure.

Step 5: Request for an EIN

After documenting the operating agreement, you should get or request an Employer Identification Number (EIN). An EIN will serve as the tax ID for your general partnership. EIN can be obtained from the Internal Revenue Service (IRS). It is a 9-digit number similar to Social Security Number. EIN, however, is distinct from SSN. It is only used for business-related activities, particularly for submitting general taxes. The form must be completed and uploaded to the IRS website.

The application of an EIN in California can be through the following:

  • Apply Online- The online EIN application is the preferred method for customers to apply for and obtain an EIN.
  • Apply by Fax- Taxpayers can fax the completed Form SS-4 application to the appropriate fax number), after ensuring that the Form SS-4 contains all of the required information.
  • Apply by Mail- The EIN application Form SS-4 can be filed via mail. The processing time frame to receive the mail is four weeks.
  • Apply by Telephone-International Applicants – International applicants may call 267-941-1099 (not a toll-free number) from 6 a.m. to 11 p.m. (Eastern Time) Monday through Friday to obtain their EIN.

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Step 6: File Form 2553 for your S-Corp Business

Once you have obtained your EIN and Articles of Organization to form an S-Corp, you must file Form 2553, Election by a Small Business Corporation, to apply for S-corp status. Filing a form 2553 should be done 75 days after the formation of your S-Corp, or at most 75 days after the beginning of the tax year in which the election is to take effect.

If your LLS-Corp has passed the deadline of 75 days, you must also file Form 8832, Entity Classification Election, to opt to be taxed as a corporation. Then you would send Form 2553 and Form 8832 jointly by certified mail from the USPS.

In California, you can file your form 2553 in the Department of the Treasury Internal Revenue Service Center – Ogden, UT 84201 Fax: 855-214-7520 .

Costs of Forming an S-Corporation

There are several costs associated with forming an S-Corporation in California, including:

  1. Filing Fees: When forming a corporation in California, you must file Articles of Incorporation with the California Secretary of State and pay a filing fee of $100 for filing online and by mail. $115 for in person filing.
  2. Statement of Information: After forming the corporation, you must file a Statement of Information (Form SI-550) within 90 days and pay a filing fee (currently $25). This statement must be filed annually after that.
  3. Franchise Tax: S-Corporations in California are subject to the annual franchise tax, which is the greater of a minimum tax (currently $800) or a calculated tax based on the corporation’s net income.
  4. Other Costs: Depending on the nature of your business, additional costs may include obtaining licenses and permits, registered agent services, and professional fees for legal and accounting services.

Advantages of Forming an S-Corporation

There are numerous advantages to incorporating an S-Corp, but you should be aware of certain problems. Consider the following benefits of an S corporation:

Pass-through Taxation

S-Corporations enjoy pass-through taxation, which helps to avoid the double taxation faced by C-Corporations. This can result in potential tax savings for shareholders. Pass-through taxation is a tax system where the income, deductions, and credits generated by a business entity, such as California General Partnership, limited liability company (LLC), or S-Corporation, are passed through to individual owners or shareholders instead of being taxed at the corporate level.

In this system, business profits and losses are reported on the owners’ or shareholders’ individual tax returns, and taxes are paid at their individual income tax rates. This avoids the issue of double taxation, which occurs in C-Corporations where income is taxed at both the corporate level and again when distributed to shareholders as dividends. Pass-through taxation is generally advantageous for small businesses and their owners, as it simplifies tax filings and often results in lower overall taxes.

Limited Liability Protection

Shareholders of an S-Corporation have limited liability protection, meaning their personal assets are protected from the corporation’s debts and obligations. Limited liability protection in an S-Corporation refers to the legal separation between the personal assets of the shareholders (owners) and the business assets, which protects shareholders from being personally responsible for the company’s debts and legal obligations.

In an S-Corporation, shareholders’ personal assets, such as their homes, cars, and personal savings, are not at risk if the business faces financial difficulties or lawsuits. The shareholders’ liability is limited to the amount they have invested in the company. This limited liability is a significant advantage of incorporating a business as an S-Corporation, as it provides a safeguard for the personal financial well-being of the business owners.

It is important to note that limited liability protection can only be supported if the shareholders maintain proper corporate formalities, such as keeping separate business and personal finances, holding regular shareholder meetings, and maintaining accurate business records. In such cases, courts may “pierce the corporate veil” and hold shareholders personally liable for the company’s debts and obligations.

Transferability of Shares

Shares in an S-Corporation are more easily transferable than those in an LLC, allowing for greater flexibility in ownership changes. Transferability of shares in an S-Corporation refers to the ability of shareholders to sell, gift, or otherwise transfer their ownership interest in the company to another person or entity. This is an important aspect of an S-Corporation’s structure, as it allows for flexibility in ownership and the potential for raising capital through the sale of shares.

However, there are certain restrictions on the transferability of shares in an S-Corporation, which are imposed by the Internal Revenue Service (IRS) to maintain the company’s eligibility for S-Corp status:

  • Shareholders: The number of shareholders in an S-Corporation is limited to a maximum of 100. Only individuals, certain trusts, and estates can be shareholders; other corporations and partnerships are generally not allowed.
  • Eligible Shareholders: Only U.S. citizens and resident aliens can be shareholders in an S-Corporation. Non-resident aliens are not allowed to hold shares.
  • One Class of Stock: S-Corporations can only have one class of stock. All shares must have the same rights and privileges, such as voting rights and distribution preferences. However, differences in voting rights are allowed if they are not tied to economic rights (e.g., distribution preferences).
  • Perpetual Existence: Perpetual existence refers to the concept that a business entity, such as an S-Corporation, can continue to exist indefinitely, regardless of changes in ownership or management. This means the corporation can outlive its original founders and shareholders and continue to operate even if individual shareholders pass away or decide to sell their shares.

This characteristic of an S-Corporation provides stability and continuity for the business, as it ensures that the corporation’s operations, contracts, and legal obligations remain unaffected by changes in ownership. It also makes it easier for the company to attract investors and raise capital. Potential investors can be confident that the business will continue to exist even if the original owners are no longer involved.

Disadvantages of Forming an S-Corporation

Despite these advantages, moving to an S corporation only sometimes makes sense – or at the very least, necessitates a thorough review of certain situations. The following issues may arise in particular:

Restrictions on Shareholders

S-Corporations are subject to specific restrictions, such as a maximum of 100 shareholders and limitations on the types of eligible shareholders (e.g., only individuals, certain trusts, and estates).

Single Class of Stock

S-Corporations are limited to issuing only one class of stock, which can limit flexibility in raising capital or creating different ownership structures. A single class of stock in an S-Corporation refers to the requirement that the corporation only issues one type of stock with equal rights and characteristics for all shareholders. This means that all shares of stock must have the same economic rights, such as dividend distribution preferences and liquidation rights, as well as voting rights. The single class of stock requirement is one of the key criteria the Internal Revenue Service (IRS) sets for a corporation to qualify for S-Corp status.

Increased Complexity

Forming and maintaining an S-Corporation requires more paperwork, record-keeping, and compliance with state and federal regulations than simpler structures like LLCs.

Franchise Tax

S-Corporations in California are subject to the annual franchise tax, which can financially burden some businesses.

In an California S-Corporation context, the franchise tax is usually based on the company’s income, net worth, or a combination of both. Since S-Corporations are pass-through entities for federal income tax purposes, meaning that their income is not taxed at the corporate level but rather passed through to individual shareholders, they may be exempt from or subject to lower franchise tax rates in some states than traditional C-Corporations.

However, S-Corporations must still comply with California franchise tax requirements, which may include annual filings and tax payments. It is crucial for S-Corporation owners to understand the specific rules and regulations in their state of operation and to consult with a tax professional to ensure compliance and minimize their tax.

FAQs

What is an S-corporation?
An S-corporation is a corporation that has made a special election with the IRS to be treated as a pass-through entity for tax purposes.
How much does it cost to start an S-corporation in California?
The fee to file Articles of Incorporation with the California Secretary of State is currently $100.
How many shareholders must an S-corporation have in California?
An S-corporation in California can have no more than 100 shareholders.
Are there any restrictions on who can be a shareholder of an S-corporation in California?
Yes, shareholders of an S-corporation in California must be U.S. citizens or residents, estates, or certain types of trusts.
How is an S-corporation taxed in California?
S-corporations in California are generally taxed like partnerships, meaning that the company’s income is passed through to its shareholders and taxed on their individual tax returns.
Is there a minimum amount of capital required to start an S-corporation in California?
No, there is no minimum capital requirement to form an S-corporation in California.
How do I file for S-corporation status in California?
To become an S-corporation in California, the corporation must file Form 2553 with the IRS and California FTB.
Is there a deadline to file for S-corporation status in California?
Generally, a corporation must file Form 2553 by March 15th of the tax year in which it wishes to become an S-corporation in California.
Can an LLC be an S-corporation in California?
Yes, an LLC (Limited Liability Company) may be eligible to be treated as an S-corporation for tax purposes in California.
Are there any disadvantages of forming an S-corporation in California?
Some disadvantages of forming an S-corporation in California include restrictions on ownership, restrictions on the number of shareholders, and potential difficulties in raising capital.
Do S-corporations in California have to file an annual report?
Yes, S-corporations in California are required to file an annual report with the Secretary of State.
Can S-corporations in California issue preferred stock?
No, S-corporations in California may not issue preferred stock.
Can I use a business name for my S-corporation in California that is different from my personal name?
Yes, you may use a business name for your S-corporation in California that is different from your personal name.
What is the process for dissolving an S-corporation in California?
To dissolve an S-corporation in California, you must file dissolution documents with both the California Secretary of State and the California Franchise Tax Board.
Do S-corporations in California have to pay state income taxes?
Yes, S-corporations in California are subject to state income taxes.
Are there any residency requirements for S-corporation shareholders in California?
No, there are no residency requirements for S-corporation shareholders in California.
How long does it take to form an S-corporation in California?
The time it takes to form an S-corporation in California varies but can typically take anywhere from 1-4 weeks.
How often must S-corporations in California hold meetings?
S-corporations in California must hold 1 shareholder meeting per year, and keep documentation of what took place during the meeting.
Are there any annual fees required to keep an S-corporation in good standing in California?
Yes, S-corporations in California are required to pay an annual Franchise Tax Board fee of $800 to remain in good standing.
Can non-profit corporations be an S-corporation in California?
No, non-profit corporations in California are prohibited from filing for S-corporation status.
Can an S-corporation in California change its tax status at a later date?
Yes, an S-corporation in California may elect to change its tax status to a regular corporation or a different entity type at a later date.
Does a California S-corporation need to have a board of directors?
No, a board of directors is not required for California S-corporations.
Can one person own an S-corporation in California?
Yes, one person can own an S-corporation in California.
Does a California S-corporation need to hold an annual meeting of shareholders?
Yes, a California S-corporation debe mantener una reunión anual para accionistas.
Can an S-corporation in California hold shares of other companies?
No, S-corporations in California are prohibited from being shareholders of other companies.
Can an S-corporation in California pay dividends to its shareholders?
Yes, S-corporations in California can pay dividends to their shareholders.
Can an S-corporation in California have multiple classes of stock?
No, S-corporations in California are prohibited from issuing multiple classes of stock.
What is the advantage of filing for S-corporation status in California?
The main advantage of filing for S-corporation status in California is that the company’s profits and losses are passed through to the shareholders, who report the company’s income on their personal tax returns. This can result in significant tax savings for small business owners.
How do I register my S-corporation in California?
You can register your S-corporation by filing Articles of Incorporation with the California Secretary of State.
Do I need a business license to operate my S-corporation in California?
Yes, you will need a business license to operate your S-corporation in California. You will need to obtain it from the city or county where your business is located.
Do I need to file a DBA (doing business as) in California?
Yes, if your S-corporation intends to conduct business under a name that is different from the name you used to incorporate the company, you will need to file a DBA in California.
What is the California franchise tax?
The California franchise tax is an annual tax that all corporations (including S-corporations) doing business in California are required to pay. The tax is based on the amount of income earned by the corporation.
What is the minimum number of shareholders required to form an S-corporation in California?
There is no minimum number of shareholders required to form an S-corporation in California.
Can non-US residents form an S-corporation in California?
Yes, non-US residents can form an S-corporation in California, but they will need to have a US resident registered agent.
Can a corporation be its own registered agent in California?
No, a corporation cannot serve as its own registered agent in California.
What is the California Secretary of State’s processing time for forming an S-corporation?
The California Secretary of State’s processing time for forming an S-corporation is generally between 2-3 weeks.
How do I change the registered agent for my S-corporation in California?
You can change the registered agent for your S-corporation in California by filing a Statement of Information with the California Secretary of State.
Can an S-corporation be a subsidiary of another corporation in California?
Yes, an S-corporation can be a subsidiary of another corporation in California.
How do I dissolve my S-corporation in California?
You can dissolve your S-corporation in California by filing the necessary paperwork with the California Secretary of State.
What is the difference between an LLC and an S-corporation in California?
While both LLCs and S-corporations offer limited liability protection to their owners, they are taxed differently. LLCs are taxed as pass-through entities while S-corporations can choose to be taxed either as a pass-through entity or as a corporation.
Are S-corporations required to pay the California minimum franchise tax every year?
Yes, all corporations (including S-corporations) doing business in California are required to pay the minimum franchise tax every year.
Can a corporate officer also be the registered agent for an S-corporation in California?
Yes, a corporate officer can also be the registered agent for an S-corporation in California.
How much does it cost to form an S-corporation in California?
The cost to form an S-corporation in California is $100 plus an additional $15 for a certified copy of the Articles of Incorporation.
Can an S-corporation have multiple classes of stock in California?
No, an S-corporation cannot have multiple classes of stock in California.
Is there a difference between a foreign corporation and an out-of-state corporation in California?
No, the terms “foreign corporation” and “out-of-state corporation” are often used interchangeably in California.
Can an LLC convert to an S-corporation in California?
Yes, an LLC can convert to an S-corporation in California by filing an election with the IRS.
Is an S-corporation required to have bylaws in California?
While it is not required by law, it is a good idea for S-corporations to have bylaws to govern their internal operations.
Can an S-corporation elect to be taxed as a C-corporation in California?
Yes, an S-corporation can elect to be taxed as a C-corporation in California.
Can an S-corporation be a general partner in a partnership in California?
No, an S-corporation cannot be a general partner in a partnership in California.
What is the maximum number of shareholders allowed for an S-corporation in California?
The maximum number of shareholders allowed for an S-corporation in California is 100.
Can an S-corporation make political contributions in California?
No, S-corporations are not allowed to make political contributions in California.
Do non-profit organizations need to pay the California franchise tax?
No, non-profit organizations are not subject to the California franchise tax.
Is a board of directors required for an S-corporation in California?
While a board of directors is not required by law for an S-corporation in California, it is often a good idea to have one to ensure that the company is run smoothly.
Can an S-corporation hire independent contractors in California?
Yes, an S-corporation can hire independent contractors in California.
Does California recognize the Series LLC form of business entity?
No, California does not recognize the Series LLC form of business entity.
How do I obtain an employer identification number (EIN) for my S-corporation in California?
You can obtain an EIN for your S-corporation in California by applying online through the IRS website.

Also Read

Why You Should Start California S Corp

There are several reasons why starting a California S Corp might be a good choice for your business. One of the key benefits of an S Corp is its pass-through taxation structure. This means that the business itself does not pay taxes on its profits; instead, those profits are passed on to the shareholders, who report them on their individual tax returns. This can result in significant tax savings for business owners compared to other business structures.

Another advantage of forming a California S Corp is the limited liability protection it offers to shareholders. In the event that the business incurs debts or faces legal action, the shareholders’ personal assets are generally protected from being used to satisfy these obligations. This can provide peace of mind and financial security to business owners, especially in industries with a higher risk of lawsuits or liabilities.

Additionally, an S Corp allows for flexible ownership structures, making it easier to attract investors or partners. Unlike a traditional C corporation, which can have an unlimited number of shareholders, an S Corp is limited to 100 shareholders. This can be a benefit for smaller businesses looking to maintain control and autonomy over their operations while still having the option to bring on outside investors.

In terms of management, a California S Corp is structured with a board of directors and officers, which can help establish clear roles and responsibilities within the company. This can be particularly helpful for larger businesses or those with multiple stakeholders, as it provides a clear framework for decision-making and governance.

Finally, forming a California S Corp can also enhance the credibility and professionalism of your business. Many customers, vendors, and partners prefer to work with established entities, and having the designation of an S Corp can lend a sense of legitimacy and stability to your brand. This can open up new opportunities for growth and expansion as you build relationships within your industry.

Of course, there are also some drawbacks to consider when it comes to starting a California S Corp. For example, there are more stringent requirements for record-keeping and reporting compared to other business entities. Additionally, the process of forming an S Corp can be more complex and costly than other options, such as a sole proprietorship or partnership.

Overall, the decision to start a California S Corp is a significant one that should not be taken lightly. However, for many entrepreneurs, the benefits far outweigh the drawbacks. If you are looking to maximize tax savings, protect your personal assets, attract investors, and establish a professional reputation, forming a California S Corp might be the right choice for your business.

Conclusion

Forming an S-Corporation in California can be a beneficial decision for small business owners seeking liability protection, pass-through taxation, and easier transfer of ownership. By meeting the requirements set by the IRS and following the necessary steps, business owners can take advantage of an S-Corp’s unique structure and benefits. However, it is essential to consider the potential drawbacks, such as increased paperwork and limitations on ownership, before making a final decision. Consulting with a legal or financial professional can help business owners determine if an S-Corporation is right for their needs and goals.

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