Information That Will Help You Understand the California S Corporation or S-Corp
California S – Corporation Taxation
Once you have chosen to undergo California incorporation, you will need to select an S or C corporate structure. A C – corporation is the generic structure. Entrepreneurs who want a California S – corporation must petition for this classification.
Although a California S – corporation files a corporate tax return, S – corporations undergo pass-through taxation, just like California LLCs. The California S – corporation does not pay taxes on its income; instead, taxation occurs at the individual level.
The owner of a California S – corporation pays self-employment taxes on income from the company. If the S – corporation earns more money than is paid to the owner as a salary, these funds can escape taxation as self-employment wages.
S – corporations are expected to maintain a managing shareholder, who must receive what the IRS considers a “reasonable salary.” Officers must also receive a salary deemed acceptable by the IRS. This salary is distinct from the cut of company profits, or the dividends, received by a managing shareholder and officers. Beware of paying your managing shareholder a low salary and high dividends. The IRS recognizes this as an attempt to pay lower Medicare and Social Security taxes, and you may be audited.
Losses suffered by the owners of a California S – corporation are passed along to shareholders, and can decrease the amount of taxes owed upon filing individual income tax returns.
Taxation benefits constitute some of the main reasons California entrepreneurs opt for an S – corporation instead of a C – corporation. An accountant and California incorporation lawyer can advise you on how to take advantage of California S – corporation taxation.
California S – Corporation Management and Ownership
California S – corporations must adhere to certain requirements regarding who can act as a shareholder in the company. Restrictions include:
A California S – corporation can have no more than 100 shareholders.
Shareholders of a California S – corporation must be US citizens or permanent residents.
A California S – corporation cannot be owned by most trusts, partnerships, other S – corporations, LLCs, or C – corporations.
California S – corporations are required to have directors to handle big-picture issues, and officers to handle daily operations.
Read additional details regarding California S – corporation management requirements in the section California Corporation Management and Ownership.
Establishing a California S – Corporation
If you wish to structure your business as an S – corporation, you and your incorporation lawyer must take action, since the C – corporation structure is the default for California businesses.
Your California incorporation attorney will help you file Form 1120S with the IRS, which requests pass-through taxation for your new California corporation. You must also file Form 2553 with the IRS. This form requires adherence to complicated timing requirements, which will determine when your S – Corporations is recognized by the state as a separate entity that can enjoy pass-through taxation. You only need to file California incorporation documents at the federal level for your S – corporation to be recognized.
Who Should Chose a California S – Corporation
Advantages Unique to California S – Corporations
California S – corporations are ideal for small to medium businesses looking to benefit from a traditional corporate structure, as well as pass-through taxation. However, a California S – corporation offers many additional benefits. For example, Operating a California S – corporation can help you control the amount you pay on Medicare and Social Security taxes by establishing payment for shareholders and staff within flexible parameters.
Like C – corporations, California S – corporations enjoy a decreased audit risk compared to California LLCs, since Form 1120 S U.S. Income Tax Return, which is used by S – Corporations, is less likely to be audited than individual income tax returns.
Disadvantages Unique to California S – Corporations
The primary disadvantage of the California S – corporation is the regulations and requirements your business must meet in order to enjoy the same tax benefits of the California LLC. If you do opt for an S – corporation, you will require the services of a skilled California incorporation lawyer to ensure that you stay on top of changing regulations. Requirements for S – corporations are notorious for their frequent updates, and failing to comply with changes, even if you are unaware of them or fail to comply only temporarily, can result in fines and additional taxes.