How to Start an S Corp in California

n S Corporation, or S Corp, is a corporation with a special tax status. If you started a small business in California, you might benefit from forming an S Corp to save on your self-employment taxes, protect your personal assets, and help your business grow. Most California businesses can elect to convert to an S Corp. But it might not be worth it for everyone—forming an S Corp requires time, money, and plenty of paperwork.

This guide will walk you through how to form an S Corp in California—from choosing your name to picking the right business checking account—to help you decide if electing S Corp status is the right choice for your business.

What is an S Corp?

An S Corporation isn’t actually a distinct type of business; it's a tax status. S Corps are taxed as pass-through entities. That means the corporation’s income, losses, credits, and deductions flow through the elected shareholders and are reported on their personal tax returns. In a C Corporation, on the other hand, income is taxed at the corporate and shareholder level.

S Corps in California are subject to the same laws as LLCs and for-profit companies. Your business can elect to be taxed as an S Corp as long as it meets the IRS’ requirements. An S Corp must:

• Be a U.S.-based business
• Have no more than 100 shareholders
• Have only allowable shareholders (partnerships, corporations, and non-residents are not allowed)
• Have one class of stock

Certain corporations, including some financial institutions, international sales companies, and insurance companies are considered ineligible for S Corp status.

Advantages of starting an S Corp in California

There are a number of advantages to forming an S Corp in California, including:

• Pass-through taxation: With pass-through taxation, your business isn’t subject to corporate income tax. Income is taxed through the shareholders’ personal taxes.
• No self-employment taxes: In an S Corp, business owners can take a salary without self-employment taxes. This can be an advantage for a single-person business or partnership.
• Scalability: An S Corp can be easily converted to a C Corp as your business grows. It can also help you to maximize your annual income and retirement savings.
• Protected assets: S Corp status protects a business owner’s personal assets. That means creditors can’t come for your house or personal accounts to satisfy business debts.

Disadvantages of starting an S Corp in California

S Corp status can be helpful for a growing business, but it isn’t right for everyone. Here are a few downsides to forming an S Corp:

• Shareholder restrictions: An S Corp can only have up to 100 shareholders and they must be U.S. residents.
• Calendar year taxation: Most S Corps are required to adopt the calendar year as their tax year, instead of using a fiscal year.
• Fees and paperwork: Forming an S Corp in California requires more steps and paperwork than starting an LLC in California. California S Corps are also subject to annual fees, including the $800 minimum franchise tax each year.

How to Form an S Corp in California

Starting an S Corp in California involves filing articles of incorporation, appointing directors, and drafting bylaws—plus a few more steps. We’ll break the process down in detail below.

1. Choose a business name

The first step in forming your S Corp is choosing a business name. This might seem like the easy part, but there are a few rules you have to follow.

According to California law, any corporation’s name must be:

• Unique and distinguishable from other corporations
• Not misleading (your name can’t suggest that your business offers a service or product you don’t offer)

Once you have a name in mind, you can check its availability through the California business database.

Reserving your name

You can reserve your name online with the California Secretary of State. For a $10 fee, your name will be reserved for 60 days. It’s possible to renew the reservation if you haven’t formed your S Corp within 60 days, but you’ll have to wait at least one day before you resubmit.

2. File Articles of Incorporation

Articles of incorporation are a type of public document filed with the Secretary of State to officially register a corporation. The document features details about your business, including:

• Business name
• Official address
• Registered agent (the person or entity who will receive and manage business documents)
• Number of shares
• How long your corporation will last (if you don’t plan to grow indefinitely)
• Statement of purpose
• Signatures of each incorporator

In California, you can file your articles of incorporation online or in person with a $15 handling fee. It costs $100 to file.

3. Appointing directors

An S Corp, like a C Corp, must have a board of directors. Directors represent the company and make decisions on behalf of the shareholders. If your S Corp has more than three shareholders, you’ll need to appoint at least three directors. S Corps with fewer than three shareholders must have a director per shareholder.

So, if you’re a single-person business, you can technically serve as the entire board of directors. However, you might want to reach out to someone with business or industry expertise to serve on your board. That could include:

• Current employees
• Past employees
• Business mentors
• Friends or family

The directors must be elected by the shareholders and named in your corporate paperwork, including your bylaws. S Corps are also required to hold board meetings. You’ll have to submit meeting minutes with your corporate paperwork each year to maintain S Corp status. (Yes—this rule still applies if you’re the only director, shareholder, and employee of your business).

4. Draft bylaws

Next, you’ll have to establish rules for your business. Corporate bylaws are guiding principles for how a business operates, and they’re established at the formation of every corporation. Your bylaws should include:

• Basic information about your business (name, purpose, etc.)
• Names of your board of directors
• Director roles
• Rules for board meetings
• Rules for shareholders' meetings

You don’t need to file your bylaws with your articles of incorporation. However, you should keep a formal record of them to prove your S Corp status in case you’re audited.

5. Obtain Business Licenses and Permits

You'll need a business license to legally operate your business in California. Requirements to obtain your license depend on the type of business you're opening. For example, a restaurant must meet certain health and safety requirements to get (and maintain) its business license.

To figure out which kind of license and permits you need, look up your city and business type in California's Go-Biz portal.

6. Obtain an Employer Identification Number (EIN)

If you don’t already have an EIN, you’ll need one to form your S Corp. An EIN, or employer identification number, is a unique number the IRS uses to identify your business. You can think of it as a social security number for your company.

Not all businesses are required to have an EIN. If you’re a sole proprietor with no employees, you might not have an EIN for your business. However, you will need one to operate your business as an S Corp. An EIN is also required to open a business checking account.

You can apply for your EIN online, by fax, or by mail (applying online is generally the fastest route).

7. Open a business checking account

Once you have an EIN for your S Corp, it’s time to open—or upgrade—your business checking account.

Novo is an online banking platform that offers free business checking to S Corps (and all business types) across the U.S. Opening an account with Novo is free and takes less than 10 minutes. You’ll also have access to tons of business-friendly features like automation, built-in customer support, and financial insights.

8. Acquiring S Corporation status

Once your corporation is named and registered, you’ll need to acquire S Corporation status by filing Form 2553 with the IRS. Without this step, your business will be registered as a C corp by default. Form 2553 must be filed within 2 months and 15 days of the beginning of the tax year you want your S Corp status to take effect.

In other words, if you file Form 2553 after the first 2 months and 15 days of the year, your business won’t be taxed as an S Corp until the next tax year.

S Corp taxation

For many business owners, acquiring S Corp status won’t change the day-to-day function of your business. It will, however, affect how your business is taxed. S Corps are taxed as pass-through entities, so you and your shareholders will pay income tax on your personal returns, instead of the business being taxed as an individual entity.

That said, you will still have to file taxes for your business. California taxes S Corps at a rate of 1.5% for all California-sourced income. You’ll also need to file Form 100S every year, and pay the annual $800 minimum franchise tax to maintain your status as an S Corp. The franchise tax applies even if your business is inactive or running at a loss.

Final thoughts

Forming an S Corporation in California requires a few more steps than forming an LLC or sole proprietorship. You’ll need a board of directors, shareholders, corporate bylaws, and formal meetings. But once you’ve established your status as an S Corp, you can save on your self-employment taxes and enjoy asset protection and pass-through taxation as your business grows.

Not sure if starting an S Corp is worth it for your small business? It’s always worthwhile to talk to an expert. If your business is taking off and you want to make the most of it, chat with a legal expert or financial advisor about your options. Forming a California S Corp might be the best choice for you.

Regardless of your tax status, you can access safe, secure, and simplified business banking with Novo.

Novo is a fintech, not a bank. Banking services provided by Middlesex Federal Savings, F.A.: Member FDIC.

Novo Platform Inc. strives to provide accurate information but cannot guarantee that this content is correct, complete, or up-to-date. This page is for informational purposes only and is not financial or legal advice nor an endorsement of any third-party products or services. All products and services are presented without warranty. Novo Platform Inc. does not provide any financial or legal advice, and you should consult your own financial, legal, or tax advisors.