In California, you may construct a S corporation (S corp) when you form a limited liability company (LLC) or a corporation. There is a 1.5% franchise tax in California for firms who choose S corp tax classification from the IRS when applying for an EIN.
An S corporation is an IRS tax categorization that allows for pass-through taxation but is not a company structure. Business owners who choose a S corp tax status are given a salary as well as dividends. The S corp classification is used to lower a company’s tax burden.
Table of Contents
In our How to Start a S Corp in California tutorial, we’ll walk you through the steps.
Considerations Before Forming a S Corp
You must examine the following things before founding a S corporation:
Is a S corporation the best option for your company?
S corporation limitations
Why is an LLC the ideal structure for the S corporation tax status?
Are the tax benefits of a S corporation good for you?
Is a S Corporation the Best Business Structure for You?
Restrictions on S Corporations
S corporations are restricted to one class of stock and a maximum of 100 stockholders, among other limitations. For more information, see our What Is a S Corporation? guide.
Why is an LLC the best structure for S Corporation tax status?
As entrepreneurs, we feel that incorporating a S corporation via an LLC is the best option since the benefits of founding a corporation are offset by S corp limitations. LLCs are also less difficult to manage than corporations.
Are S Corporation Tax Benefits Right for You?
You must determine if the S corp tax status is preferable to the default LLC tax status for your company. Read our LLC vs. S corp tutorial to fully grasp the tax benefits of a S corp.
How to Form a S Corporation
If you’re thinking about founding a S company, you should realize that it’s a tax categorization under the Internal Revenue Service’s Subchapter S. (IRS). Because it gives tax advantages, S corp company owners choose this tax status for either an LLC or a corporation. Form 2553 must be completed and filed with the IRS to establish your California S corporation. In California, a S corporation is subject to a 1.5% franchise tax.
Corporations with the IRS tax classification C Corp face double taxation (the company is taxed, and shareholders are taxed again on business payouts), while LLCs face pass-through taxes (all profits, credits, distributions, deductions, and losses pass directly to the owner). To qualify for this form of tax categorization, the firm owner(s) must have a fair wage based on their job and the acceptable market remuneration. This results in more IRS scrutiny. Because sole proprietorships and partnerships are informal company formations, they do not qualify for S corp tax status.
S corporations have the following tax advantages:
S corporations are not taxed at the corporate level (as opposed to C corps). Earnings, losses, and deductions are passed through to the owner via S corporations (s). However, California S corporations must pay a 1.5% franchise tax, with a minimum of $800.
The owner(s) of a business must pay employment taxes as well as income taxes on their compensation.
Distributions, which are net profits (earnings after operating expenses, deductions, credits, and income), only pay income tax on each individual owner’s income tax return under the tax band in which they are taxed. The tax savings occur here since no employment tax is paid on this component!
S corporations, among other requirements, must have no more than 100 shareholders who are US citizens or permanent resident aliens.
There are two primary methods for forming a S Corp:
When requesting your employee identification number, organize an LLC and obtain S corp tax status from the IRS (EIN)
By creating a company and applying to the IRS for S corp status
We do not advocate forming a company with the S corp tax status since it undermines all of the advantages of forming a corporation.
Forming an LLC and Choosing S Corp Tax Status in California
To form an LLC and elect S corp status, follow these six simple steps:
Step 1: Give Your LLC a Name
Step 2: Select a Registered Agent.
Step 3: Submit the Articles of Incorporation.
Step 4: Submit your Initial Statement of Information.
Create an Operating Agreement in Step 5
Step 6: Obtain an EIN and complete Form 2553 to elect S Corporation Tax Status.
Step 1: Give Your LLC a Name
The first and most significant step in forming an LLC in California is deciding on a name.
Make sure your name conforms with California naming regulations and is readily searched by prospective customers.
1. Follow the California LLC name guidelines:
The word “limited liability corporation” or one of its acronyms (LLC or L.L.C.) must appear in your name.
Your LLC’s name cannot include terms that may be confused with a government organization (FBI, Treasury, State Department, etc.).
The phrases bank, trust, trustee, incorporated, inc., corporation, or corp. are not permitted in the name.
The name cannot include the terms “insurer” or “insurance firm,” or any other phrases implying that it is in the business of providing insurance policies and taking insurance risks.
The name must be distinct from that of any other LLC registered with the Secretary of State. On the California Secretary of State’s website, you may learn more about what distinguishes a name.
2. Does the name exist in California? To determine whether your selected LLC name is available, utilize the business entity search on the California Secretary of State website.
3. Is the URL accessible?
We suggest that you check to see whether your company’s name is accessible as a web domain. Even if you don’t intend to construct a company website right away, you may want to purchase the URL to prevent others from gaining it.
Step 2: Select a California Registered Agent
For a California LLC, you must appoint an agent for service of process, often known as a registered agent.
A registered agent for your LLC will accept legal papers and tax notifications on your behalf. When you submit your LLC’s Articles of Organization, you will name your registered agent.
Many company owners opt to use the services of a registered agent. Many of these firms will incorporate your LLC for a modest price and provide free registered agent services for the first year.
Step 3: Submit the Articles of Organization for the California LLC.
To properly register an LLC, the California LLC Articles of Organization are utilized.
Step 4: Submit your Initial Statement of Information.
The California Secretary of State requires you to file an Initial Statement of Information (Form LLC-12). This can be done in person, online, or by mail, but it must be done within 90 days of formation.
Step 5: Draft an Operating Agreement for your LLC.
An LLC operating agreement is a legal document that defines your LLC’s ownership and member responsibilities.
Step 6: Apply for an EIN and fill out Form 2553 on the IRS website.
An EIN is a number assigned by the US Internal Revenue Service (IRS) to companies in order to identify and tax them. It is basically a business’s Social Security number.
When you apply directly with the IRS, EINs are free.
Select S Corporation Tax Status
The IRS will give a link to Form 2553, the Election by a Small Business form, during the online EIN application process.