California S Corporation Tax: Everything You Need to Know
California S corporation tax is the state income tax charged to an S corporation, along with annual franchise taxes and other fees. 3 min read
2. Electing S Corp Status in California
Updated June 28, 2020:
California S corporation tax is the state income tax charged to an S corporation, along with annual franchise taxes and other fees. An S corporation is simpler to operate but less flexible than a C corporation, with limits as to the number and type of shareholders. Businesses and foreign nationals cannot hold shares, and the S corporation must use the annual calendar year rather than a fiscal year.
An S corporation that provides its shareholders with health insurance can deduct this cost as a business expense, but it is taxed at the individual level as part of shareholder compensation. Many small businesses opt to form an S corporation because of the tax benefits and limited liability protection this structure offers.
To form an S corporation in California, you must create a traditional corporation and then elect S taxation status with the IRS by filing Form 2553. If you want to be treated as an S corp for tax purposes, your articles of incorporation must indicate that only one class of stock is offered.
With an S corporation, profits are not taxed at the corporate level but pass through to shareholders, who report income and losses on their individual tax returns. Although the S corp does not pay income taxes as an entity, it must file an annual informational return.
An S election is permanent unless the shareholders agree to dissolve the corporation or transform it to another entity. However, the S status can be revoked if the eligibility requirements are not consistently fulfilled.
S Corporation Taxes
S corporation shareholders report their share of business profits and losses on Schedule K-1 at tax time. In addition, the corporation must file Form 1120S as an informational return. Losses allocated to an individual shareholder are limited to his or her investment in the company.
In addition to federal taxes, California S corporations are subject to a franchise tax at a rate of 1.5 percent on net income with an annual minimum of $800 after the first year of existence. This is in addition to individual state income taxes. This differs from the tax treatment of these corporations in states where the federal S status is automatically accepted.
All S corporations that were established or conduct business in California must file their franchise taxes using Form 100S by March 15 or by the third month, 15th day after the close of the fiscal year for companies that do not use the calendar year.
In addition to the avoidance of double taxation at the federal level, California S corporations have the following tax considerations:
- Before S corporation profits can be distributed, owners that work for the company must be paid reasonable salaries from which FICA (Social Security and Medicare) taxes are withheld. Distributions that are paid to the shareholder after this reasonable salary has been paid are not subject to self-employment tax, which is a great benefit of an S corporation.
- The corporation's losses can be used to offset the shareholder's income on their individual tax returns.
- Profit and loss distributions are proportional to the ownership percentage of each shareholder, while other business structures such as the limited liability company (LLC) provide flexibility.
Electing S Corp Status in California
California S corporations do not have to make the election at the state level to have their status recognized. After you form a C corporation by filing articles of incorporation, you must enact bylaws, issue shares, and hold the initial shareholders meeting before making your S corp election. This must be done within 45 days of incorporation or you will have to wait until the next tax year to elect S corp treatment.
Corporations that do not elect S corp taxation are subject to a 15 percent corporate income tax on the first $50,000 in profits and 25 percent on additional profits. This also applies to earnings that are reinvested into the business. In addition to this corporate income tax, shareholders must pay capital gains tax on these earnings when they receive them as dividends, either 10 percent or 15 percent depending on the individual's tax bracket. It's important to consult a tax attorney when forming an S corporation in California.
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