S corporation is a tax status, not a type of corporation. In fact, LLCs and partnerships, as well as regular corporations, can elect to be taxed as an S corporation by filing Form 8832 (Entity Classification Election) with the IRS. So, the rules governing the formation of an S corporation in California are the same as those that apply to any other for-profit corporation or LLC (limited liability company). Once the corporation or LLC is formed, the election to be taxed as an S corporation is filed with the IRS.
CT Tip: If you are planning to operate your business as an S corporation, it is important that your Articles of Incorporation provide for only one class of stock (although there can be different voting rights). A corporation that has more than one class of shares cannot elect to be an S corp. Note that there are also restrictions on the number and type of shareholders. See our guide, S Corporations, for information on the restrictions imposed on S corporations.
For information on general incorporation requirements, see our article: Incorporating in California.
Electing S corporation status in California
California honors the federal S corporation election. No separate election is required at the state level.
California tax treatment of S corporations
One of the major advantages of operating as an S corporation is that an S corp is a pass-through entity for federal tax purposes. This means that there is no federal income tax imposed at the corporate level—income is taxed only on the shareholders returns.
However, not all states follow the federal government’s tax treatment. And, California is one that does not!
Although California’s tax rules generally follow the federal rules for computing the S corporation’s income, California taxes this income at the corporate level. As of January 1, 2016, an S corporation's net income is taxed at 1.5 percent. That's not all. In California, an S corporation's income is taxed a second time when it is passed through to the shareholders. Therefore, operating as an S corporation in California will mean pass-through taxation for only federal taxes.
CT Tip: LLC’s in California are also subject to entity-level tax, although the computation of income and the tax rates differ from those that apply to the S corporation. For this reason, a company that expects to pay tax in California, should work with a professional tax advisor to determine which entity type is the most tax effective.
California franchise tax imposed on S corporations
Any S corporation that is incorporated or doing business in California or that receives California source income must file Form 100S (California S Corporation Franchise or Income Tax Return) by the 15th day of the 3rd month after the close of the S corporation's tax year. Plus, every S corporation incorporated or doing business in California must pay a franchise tax. The minimum amount is $800.