As the state with the most jobs in the country, California has an S corporation’s filing process that’s arguably easier than many other states.
The office of California Secretary of State is even confident enough to say that it “leaves a lot less paperwork for California business owners.”
It’s important to note, however, that while this process is easy-free for California businesses, it can be more complicated for other states.
Step 1: Choose a name.
You have to choose a name for the business. It has to be available in California. To check for availability, you can contact your city and county offices.
It’s good to make sure that it isn’t too similar to an existing company because this could cause legal issues later on.
If you’re choosing a business name that’s related to your personal identity, the content of your name has to be your legal name.
If you aren’t using your legal name, your filing article must have the true, complete business name. This is in order to avoid being deceptive with the public.
Your business will include two names: a DBA (Doing Business As) and an assumed name. If you’re a sole proprietor, the DBA will be your personal name and the assumed name will be your business name. If you’re a partner, it will be the other partner’s name as DBA and his or her assumed name.
Step 2: Appoint directors.
You must have at least two directors. One of them is, of course, the president or shareholder of a California S corporation. The other one is supposed to be a “principal officer” (the director who has responsibilities related directly to business operations).
If you are an individual, you can appoint a spouse to act as a director.
Step 3: Appoint a registered agent for service.
If the business has a physical address in California, it must have a registered agent. You can be your own registered agent, but if you don’t want to do that, you’ll need to appoint a registered agent.
The registered agent must receive legal documents on behalf of the business.
Step 4: Draft and file Articles of Incorporation.
You have to draft and file Articles of Incorporation with the office of the California Secretary of State. The California articles must include the name of the company, registered agent, phone number, website address, mailing address, and physical address of the registered agent.
Step 5: File a Statement of Information.
You have to file form of the Statement of Information with the office of the California Secretary of State. The statement will include more information about the company, such as:
- Name and address of all shareholders and directors.
- List of a corporation’s registered agent for service of process and registered office in California.
- The business purpose for which the California S corporation is formed.
You’ll have to file an Annual Statement of Information with your office of Secretary of State before the anniversary date. As only the correct information must be filed. You’ll also need to provide a physical address for the company.
You need to file all the necessary paperwork with the office of the Secretary of State before your Articles become effective.
Step 6: Apply for the status of California S corporation with the internal revenue service IRS.
This is the most complicated part since you have to apply for tax exemption with the internal revenue service IRS. You will also need to make sure that your business meets the requirements, how much profit you make as an individual, and how many shareholders you have.
California has a different tax code than other states. It’s really important to understand how your business is going to be taxed because of the differences.
Because California is one of the more progressive states, there are some major differences. For instance, you can’t report using an individual tax return.
There are some serious ramifications when you choose how to file your tax purposes. For instance, at the time of writing this article, California has some corporate records of a tax rate of 8.84%.
Meanwhile, filing as an S Corporation means that you’ll be taxed at the individual level and that rate will depend on where you live.
A major benefit of choosing to be an S corporation is that it eliminates double taxation issues.
What is the tax status rate to form a corporation?
In the state of California, S corporation’s payment is 8.84% on the taxable profit. This will apply at both the corporate and individual levels. However, if you live outside of California, this rate might not apply to your S corporation if it’s a closely held corporation.
Prepayment upon incorporation
S corporations cannot elect to prepay taxes. Instead, they must wait until the end of the year in which taxable profit is earned before filing for an assessment.
What are the requirements for forming an S corp in California?
There are some specific requirements that you’ll have to meet if you want to form an S corporation in California:
- You must be a U.S. citizen or resident alien in California.
- The business entities cannot be owned by and controlled by non-U.S. citizens or residents.
- You must be a resident of California.
- You must have a place of business in California.
What are the benefits of S corporation in California?
- Avoiding double taxation. The S Corporation is taxed at the corporate level and the individual level (but only when you have employees).
- Making it easier to raise capital. Because of the way that S corporations are structured, you have a better chance of raising capital if you’re trying to achieve success.
The Downsides of S Corps
Double taxation can be an issue. Because of the structure of S corporations, the corporation status is treated as a pass-through entity. This means that the corporation itself doesn’t pay taxes.
Certain shareholders in California have a cap on how much they can earn, which means that they won’t be taxed by any profit passed through by the S corporation.
How do your taxes change when you’re an S Corp?
To illustrate how your S corporation taxes work, let’s imagine that you own a small business. Your company earns $10,000 in profit this year. This income isn’t taxed until it is paid out to you personally. You’ll receive dividends of $100, which are then taxed at your personal tax rate. Your total tax will be $11,000.
If you’re filing as an individual, you’ll receive the same profit. But remember that non-resident aliens and high-earning individuals have a cap on their final paychecks when reporting as an individual. In this example, you’ll receive $10,000 because of the California S corporation limitations. Your total tax status is $11,000.
How to get S Corp tax treatment in California
You need to do more than just file a few papers. Here, we’ll walk you through the steps.
You must file:
- Articles of Incorporation with the Secretary of State.
- Articles of Incorporation with the Corporations Division of the California Department of Corporations (DCC).
- Your Articles of Incorporation with the Secretary of State. Wait 30 days after filing your Articles.
- Your Form 521 with the DCC, which is another free process that takes about two weeks to complete. You can include this even if you don’t have any taxable profit.
- Form 521-A (if you’re a California resident) or Form 521-EZ (if you’re not a California resident) with the DCC, which is another free process that takes two weeks to complete.
California Corporation Taxation
Corporations operating in California are subject to three different forms of how to pass through taxation:
Franchise Tax :
Every calendar year, a franchise tax rate applies to both domestic and foreign corporations doing business in California. FTB rates vary depending on whether the California corporation is classified as a Domestic or Foreign Corporation. The income tax must be at least $800 regardless of the company’s legal classification.
Corporate Net Profits Tax :
Corporations are subject to a state tax on its net income if it is engaged in business in California. The amount is based on the adjusted federal tax profit and includes only 80% of the depreciation deduction.
Sales & Use Tax:
Sales & Use Tax applies to all goods sold in California whether you live here or not. You must pay the tax on the date invoices are issued or received.
Calculating State Business Tax Rates
The California Franchise Tax Board, known as California’s FTB, provides an online calculator that you can use to calculate your state income tax status based on your yearly and quarterly income. Use the FTB tax calculator.
Choosing a California limited liability company (LLC) or S Corp
If you plan to incorporate in California, then you should consider whether you want to form a C corporation or an S Corporation.
If you choose to form an S Corporation, then you need to make sure that you meet the following criteria before filing articles of incorporation:
- You cannot own any voting stock. Voting stock gives control over the direction of the company to those who hold them. If you do not comply with this rule, then you may lose some rights granted by California law.
- Your total number of outstanding shares does not exceed 25% of the value of the combined voting power of all classes of stock entitled to vote at shareholder meetings.
- All members of the board of directors must be independent. Independent means they don’t owe their position to anyone else. They also cannot be officers or employees of another company.
- At least 75% of your issued share capital must consist of non-voting preferred stock. Preferred stock pays dividends ahead of common stock. Dividends are usually higher too.
- Any member of your management team must sign off on each financial statement with the SEC.
Sole proprietorship vs. limited liability company (LLC)
A sole proprietor operates under his/her personal name. In order to protect yourself against lawsuits, you’ll likely need to purchase insurance through a third-party provider.
A sole proprietorship allows you to keep 100 percent ownership of your business. However, because you’re personally liable for everything that happens inside the company, you won’t get much help from banks or investors.
CA S-Corp Tax Rates
California State Income Tax Rates for forming an S Corporation:
- 0% on the first $250,000 of profit subject to tax,
- 8.84% on that portion of profit greater than $250,000 but less than $500,000, and
- 11.30% on that portion of profit greater than $500,000 and less than or equal to $1 million.
- 12.31% on profit greater than $1 million and less than or equal to $2 million,
- 13.33% on profit greater than or equal to $2 million and less than or equal to $5 million,
- 15.34% on profit greater than or equal to $5 million and less than or equal to $10 million,
- 16.35% on profit greater than or equal to $10 million and less than or equal to $25 million, and
- 17.465% on profit greater than $25 million.
Where does an S-Corp file Taxes?
An S-corporation is responsible for filing income taxes in two ways depending on whether it has a single owner or multiple business owners.
Can you combine benefits for S Corps and LLCs?
Yes. S-Corp and LLC filing combined.
As long as the California business has fewer than 100 shareholders, it may choose to file as either an S-corporation or a partnership.
The main advantage of limited liability company (LLC) vs S Corp is that you have a lot more flexibility with the allocations between salary and distributions of profits to business owners.
What is the difference between S Corporation and C Corporation?
The main differences are:
- The most significant difference is that an S Corporation does not pay corporate profit tax on earnings.
- There are no restrictions on the number of shareholders in an S Corporation.
- Generally, there are no limits on what employees and managers can be paid in an S Corporation. In contrast, a regular California corporation must comply with rules that limit director and officer salaries.
- S Corporations are required to have a valid federal employer identification. This means that to form a corporation you must include information about its directors, officers, and shareholders with the IRS.