How to Start an S Corp in California
With thriving industries like film and technology, starting a small business in California can be a great opportunity. California is home to many startups and exciting new ventures — and electing S corporation (S corp) status in California is easy and could potentially save your business money on its taxes.
This guide will walk you through the process of starting a California S corp as well as provide tips on maintaining your S corp in good standing.
Want to form an S corp elsewhere? Check out our other How to Start an S Corp guides to learn more.
We recommend using a professional formation service like Northwest to get your S corp up and running in no time.
Factors to Consider Before Starting an S Corp in California
Before forming an S corp, you have to consider the following factors:
- Is an S corporation the best strategy for your business?
- S corporation restrictions
- Are S corp tax advantages right for you?
Is an S Corporation the Best Strategy for Your Business?
For help with choosing the right structure for your business, visit our Choosing a Business Structure guide.
S Corporation Restrictions
S corps have several restrictions, such as being limited to one class of stock and a maximum of 100 shareholders. Read our What Is an S Corporation guide for full details.
Are S Corp Tax Advantages Right for You?
An S corporation is a tax designation that can be elected by an LLC or corporation. With an S corp, business owners are considered employees of the company and must receive a reasonable salary. Since all S corps technically have employees, the s corp must run payroll.
In order to benefit from a California S corp tax designation, your business needs to make enough money to offset payroll expenses. Furthermore, S corps are beneficial for business owners who take large distributions in addition to their salary.
How to Form a California S Corp
If you’re considering forming an S corp, you should know that an S corporation is a tax classification under Subchapter S of the Internal Revenue Service (IRS). S corp business owners elect this tax status for either an LLC or a corporation, since it provides tax benefits. You can form your California S corp by completing and filing Form 2553 with the IRS. In California, an S corp has a franchise tax of 1.5%.
Corporations with a C Corp IRS tax classification have double taxation (business is taxed and shareholders are taxed again on business distributions) and LLCs have pass-through taxation (all profits, credits, distributions, deductions, and losses pass directly to the owner). An S corp requires business owner(s) to have a reasonable salary based on their position and the appropriate market compensation to qualify for this type of tax classification, which results in more IRS scrutiny. Sole proprietorships and partnerships do not qualify for S corp tax status since they are informal business structures.
The following are some S corp tax advantages:
- S corps are not taxed at the business level (as opposed to C corps). S corps pass through earnings, losses, and deductions to the owner(s). However, California S corps pay a 1.5% franchise tax or an $800 minimun.
- Business owner(s) pay employment taxes and income tax on their salary
- Distributions, which are net profits (profits after operational costs, deductions, credits, income), only pay income tax on each individual owner’s income tax return within their respective tax bracket. This is where the tax savings occur since there is no employment tax paid on this portion!
S corps are required to have no more than 100 shareholders who are U.S. citizens or permanent resident aliens, among other restrictions.
There are Two Main Ways to Form an S Corp:
- By forming an LLC and electing S corp tax status from the IRS when you request your employee identification number (EIN)
- By forming a corporation and electing S corp status from the IRS
We recommend forming an LLC because it’s simpler and more cost-effective.
Recommended: If you have an existing LLC, visit our How to Convert an LLC to S Corp guide.
Steps to Form an LLC and Elect S Corp Tax Status in California
Starting a California LLC and electing S corp tax status is easy. You can use our guides to start an LLC with the S corp status yourself, or you can hire a service provider like Northwest to guide you through this process.
There are six basic steps to start an LLC and elect S corp status:
Step 1: Name Your LLC
Step 2: Choose a Registered Agent
Step 3: File the Articles of Organization
Step 4: File Initial Statement of Information
Step 5: Create an Operating Agreement
Step 6: Get an EIN and File Form 2553 to Elect S Corp Tax Status
Step 1: Name Your LLC
Choosing a company name is the first and most important step in starting your LLC in California.
Be sure to choose a name that complies with California naming requirements and is easily searchable by potential clients.
1. Follow the naming guidelines for a California LLC:
- Your name must include the phrase “limited liability company,” or one of its abbreviations (LLC or L.L.C.)
- Your name cannot include words that could confuse your LLC with a government agency (FBI, Treasury, State Department, etc.).
- The name cannot include the following words: bank, trust, trustee, incorporated, inc., corporation, or corp.
- The name cannot include the words “insurer” or “insurance company” or any words suggesting that it is in the business of issuing policies of insurance and assuming insurance risks.
- The name must be distinguishable from any other LLC registered with the Secretary of State. You can read more about what makes a name distinguishable on the California Secretary of State website.
You can also read the California state statute about LLC naming guidelines for more information.
2. Is the name available in California? You can use the business entity search on the California Secretary of State website to see if your desired LLC name is available.
3. Is the URL available? We recommend checking to see if your business name is available as a web domain. Even if you don't plan to create a business website today, you may want to buy the URL in order to prevent others from acquiring it.
Find a Domain Now
Step 2: Choose Your California Registered Agent
You must elect an agent for service of process, also known as a registered agent, for your California LLC.
An LLC registered agent will accept legal documents and tax notices on your LLC's behalf. You will list your registered agent when you file your LLC's Articles of Organization.
Many business owners choose to hire a registered agent service. Many of these services will form your LLC for a small fee and include the first year of registered agent services for free.
Step 3: File the California LLC Articles of Organization
The California LLC Articles of Organization is used to officially register an LLC.
File Your California Articles of Organization
OPTION 1: File Online With the California Secretary of StateFile Online
- OR -
OPTION 2: File Form LLC-1 by Mail or in PersonDownload Form
State Filing Cost: $70 ($85 for in-person filing)
Secretary of State
Business Entities Filings
P.O. Box 944260
Sacramento, CA 94244-2600
Secretary of State
1500 11th St.
Sacramento, CA 95814
Step 4: File Initial Statement of Information
You must file an Initial Statement of Information (Form LLC-12) with the California Secretary of State. You can do this in-person, online, or via the mail — but no matter what, it must be done within 90 days of formation.
File the Initial Statement of Information
OPTION 1: File Online With the California Secretary of State PortalFile Online
- OR -
OPTION 2: File Form LLC-12 by Mail or In PersonDownload Form
Fee: $20 online and by mail; $35 in person (Nonrefundable)
Secretary of State, Statement of Information Unit
P.O. Box 944230
Sacramento, CA 94244
California Secretary of State Sacramento Office
1500 11th Street
Sacramento, CA 95814
Step 5: Create an LLC Operating Agreement
An LLC operating agreement is a legal document that outlines the ownership and member duties of your LLC.
For more information, read our California LLC Operating Agreement guide.
Our operating agreement tool is a free resource for business owners.
Step 6: Get an EIN and Complete Form 2553 on the IRS Website
An EIN is a number that is used by the US Internal Revenue Service (IRS) to identify and tax businesses. It is essentially a Social Security number for a business.
EINs are free when you apply directly with the IRS.
Elect S Corp Tax Status
During the online EIN application, the IRS will provide a link to Form 2553, the Election By a Small Business form.
Visit our Form 2553 Instructions guide for detailed help with completing the form.
This is the form to elect S corp tax status for your LLC:
Keep Your California S Corp Compliant
After you successfully form your business and elect the S corp tax designation for it, you must follow state laws to ensure your business remains compliant and can continue to operate in good standing. All California S corps need to file a Statement of Information every two years and a Form 100S each year.
California Statement of Information
Your California S corp must file a Statement of Information with the California Secretary of State every other year. If you registered your business in an odd year, for example, you’ll file this report during every following odd year. The filing deadline is based on your business’s original registration date.
Visit our California Statement of Information guide for more information.
California S Corp Taxes
S corporations benefit from pass-through taxation, meaning the business’s profits pass-through to S corp owners’ individual tax returns. S corp owners make money from their reasonable salary and distributions, and California S corp owners can expect to pay the following taxes:
Federal Self-Employment Taxes
Self-employment taxes cover social security and medicare. The self-employment tax rate is 15.3%, and money you take as salary will be subjected to the self-employment tax. However, distributions are not subjected to this tax.
Federal Income Taxes
Your federal income taxes will depend on your tax bracket, and the cutoffs for individual tax brackets as well as the percent owed will change each year. Both your salary and distributions are subjected to federal income tax.
California Franchise Tax
All S corps within the state must file Form 100S each year and pay California’s franchise tax. The California franchise tax rate is 1.5% on net income, and the minimum franchise tax rate is $800 by default. That means your S corp will need to pay at least $800 each year even if it’s inactive or loses money.
Form 100S is due by March 15 each year, and you should file it with the California Secretary of State. As an S corp owner, you’re responsible for paying the California franchise tax in addition to state income taxes.
California Income Taxes
California has some of the highest income tax rates in the country. Similar to federal income taxes, the California state income tax rate varies based on your yearly income and if you file as an individual or with your spouse. While the lowest rates start at 1%, the highest tax rates can exceed 10%.
Because a 10% state income tax rate is significantly higher than that of other states, you should keep this in mind when deciding if California is the best place for you to do business.
California Sales and Use Tax
California’s statewide sales tax rate is 7.25%. California retailers must register with the California Department of Tax and Fee Administration to ensure they pay taxes on the goods they sell. While 7.25% is the statewide sales tax rate, many cities have their own sales tax that businesses must pay in addition to the statewide sales tax.
California Local Taxes
Check with your local municipality to ensure your business complies with local laws. Whether your business operates in Los Angeles, San Francisco, or a smaller city in the state, each local municipality may have its own taxes that apply to your business.
Start a California S Corp FAQ
No. The default taxes for an LLC and taxes for an S corp are not the same.
With an S corp, owners pay personal income tax and self-employment tax on a predetermined salary. They may then withdraw any remaining profits from the business as a “distribution,” which isn’t subject to self-employment tax.
With an LLC, all company profits pass through to the owners’ personal tax returns, and then the owners must pay personal income tax and self-employment tax on the entire amount.
S corp owners are required to earn a “reasonable” salary, which basically means a fair market rate based on the individual’s qualifications as well as their duties and responsibilities at the company. The purpose of this requirement is to prevent S corp owners from paying themselves an artificially low salary in order to pay less self-employment tax.
A distribution is a dividend that a shareholder/owner can take from the business profits that remain after a company pays all of its employee salaries. Shareholders must pay personal income tax on distributions, but distributions aren’t subject to self-employment tax.
Unlike most states, California requires businesses to file a report — called a Statement of Information — every two years. While this report may not be called an annual report, it contains the same information.
The state of California requires business entities to pay a franchise tax. This tax will either be $800 or 1.5% of your business’s annual income (whichever is greater). You must file Form 100S each year in order to account for and pay this tax.