California S-Corporation Formation

Who should form an S-Corp in California?

An S-Corp makes sense when: your business generates over $80,000-$100,000 a year in net profit, you personally take a "reasonable salary" from the business, you want to save the 15.3% Self-Employment tax on distributions (S-Corps only pay that tax on salary, not on additional profits), you have an LLC that is paying too much in taxes, or you are forming a professional business (consulting, marketing, technology). NOT recommended for small businesses under $50k/year — tax savings do not offset administrative costs.

What is included in the S-Corp package?

• ✓Articles of Incorporation (Form ARTS-GS) prepared
• ✓Bilingual English/Spanish Bylaws
• ✓Federal EIN application
• ✓Form 2553 — S-Corporation election with IRS
• ✓Initial organizational minutes
• ✓Annual $800 Franchise Tax instructions
• ✓Industry-based reasonable salary plan

California-specific rules

In California, an S-Corp pays 1.5% on net income (minimum $800 annual). Federal S-Corp election is NOT automatic in California — California taxes S-Corps as regular corporations at 1.5%. Even so, the combination of federal Self-Employment Tax savings + the lower 1.5% state rate vs. the 8.84% a regular C-Corp would pay makes S-Corp attractive. Every S-Corp must have Bylaws (not filed with state but must exist) and must file Form 100S annually.

How to form your California S-Corporation step by step

1. 1. Verify your business is eligibleYou must be a US citizen or permanent resident, maximum 100 shareholders, only one class of stock, and no corporate entities as shareholders. If you have foreign partners, you do NOT qualify for S-Corp.
2. 2. Form the C-Corp first (the base)S-Corp is NOT a legal entity — it is only a tax status. You must first form a regular C-Corporation with Articles of Incorporation (ARTS-GS) and Bylaws. California charges $100 filing fee + $25 Statement of Information within 90 days.
3. 3. Get your federal EINRequest the Employer Identification Number at irs.gov (free, same day). Without EIN you cannot file Form 2553 or open a corporate bank account.
4. 4. File Form 2553 with the IRSThis is the form that converts your C-Corp into S-Corp for tax purposes. Deadline: 75 days from formation OR within the third month of the fiscal year. Missing this deadline leaves you as C-Corp paying 21% federal instead of pass-through.
5. 5. Set up your payrollThe IRS requires the owner-employee to receive a reasonable W-2 salary. Configure payroll (Gusto, ADP, QuickBooks) BEFORE taking the first distribution. Missing this is the #1 cause of S-Corp audits.
6. 6. Document your "reasonable salary"Compare with Bureau of Labor Statistics or salary.com for your industry + experience + location. Keep documentation. If the IRS audits, this is the first thing they will ask for.
7. 7. Maintain corporate formalitiesAnnual minutes, board resolutions, shareholder register. The S-Corp loses its protection if the IRS or a plaintiff proves it is a sham "alter ego" without real formality.

Common California S-Corp formation mistakes

• ⚠Paying yourself only via distributions, no W-2 salaryIt is the #1 trap that destroys S-Corps. The IRS reclassifies EVERYTHING as salary subject to 15.3% Self-Employment Tax + penalties + interest.
• ⚠Missing the Form 2553 deadline75 days from formation. If you miss the deadline, you remain a C-Corp paying 21% federal until next fiscal year. Some late elections qualify under Rev. Proc. 2013-30 but require a tax attorney.
• ⚠Underestimating ongoing administrative costPayroll processor ($40-100/mo), CPA for Form 1120-S ($600-1,500/year), California Form 100S, corporate maintenance. If your profit is <$60k/year, cost eats savings.
• ⚠Paying yourself a "reasonable salary" too low$20k salary + $200k distributions is a red flag for the IRS. The salary should reflect what you would pay an outside employee for the same work.
• ⚠Forgetting California $800 minimum franchise taxYou owe $800 even if the S-Corp has $0 income. It is the trap for those who assume S-Corp "pays no taxes" — California does charge the minimum.

Frequently Asked Questions

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