by LawInc Staff
November 22, 2021
When you form an S corporation, in California, it is critical that every step is carefully completed to ensure maximum liability protection and tax issues, in case of an IRS or California Franchise Tax Board audit.
Don’t risk your assets.
Accordingly, consider the following if you would like to form an S corporation in California.
Form an S Corporation in California With an Attorney
Many take the inexpensive route when incorporating.
This can be very costly in the long run.
It is essential that you consult with an attorney, before starting the incorporation process for multiple reasons.
Timing, liability issues, tax questions, formalities and more, are important issues to discuss when starting an S corporation in California.
If you would like a California licensed attorney to properly form your California S corporation, simply use our secure online portal or call us at (310) 765-2525.
Determine Whether You Should Form a C or S Corporation
Before incorporating, determine whether it is better to be taxed as a C or S corporation.
The first, and default, tax status is taxation as a C corporation.
C corporations are treated as separate entities for tax purposes.
This means that the corporation files its own tax return and pays its own taxes. In turn, the medical corporation’s owners file their own and separate tax returns in an individual capacity.
This results in what is commonly referred to as “double taxation.”
While not necessary problematic under all circumstance, most business owners prefer to avoid this tax status and opt to be taxed as an S corporation.
The “S” refers to a specific section of the internal revenue code which dictates how the corporation is taxed (26 U.S. Code Subchapter S).
S corporations are also referred to as “small business corporations.”
It is important to consider the benefits of an S corporation.
The main benefit is that you avoid the double taxation associated with C corporations. This is referred to as “pass-through” taxation.
When forming a California S corporation it is important to ensure that you meet the eligibility requirements.
Here are some of the applicable restrictions:
No More Than 100 Shareholders
S Corporations cannot have more than 100 shareholders (a husband and wife qualify as one shareholder);
Make Sure all Shareholders are US Citizens or Residents When You Form an S Corporation in California
All shareholders must be citizens or residents of the United States. Non-resident aliens may not hold shares.
All shareholders must be individuals and not other corporations or LLCs (estates, some exempt organizations and certain trusts qualify as shareholders).
One Class of Stock
Only one class of stock is permitted (differences in voting rights are allowed);
The company making the election cannot be a bank or thrift institution, an insurance company, or a domestic international sales corporation;
Each shareholder must consent to the S corporation tax status; and
No more than 25% the company’s gross corporate can come from from passive investment activities.
If You Form an S Corporation in California With More Than One Owner You Should Prepare a Buy-Sell Agreement
An often critical mistake when forming an S corporation, with more than one owner, is failing to account for what happens to the corporation if one of the shareholders/owners dies, becomes incapacitated, gets a divorce or wants to sell his/her ownership interest to a third party.
Without a buy-sell agreement (also known as a shareholder agreement) such circumstances will not be accounted for.
That is, by default, there are no provisions governing what happens to the corporation, and its stockholders, under such situations.
During the formation process,most shareholders get along great.
However, circumstances often change in the future and there must be an agreement, in place, which dictates what happens when unforeseen circumstances arise.
Be sure to consult with your attorney about a buy-sell agreement.
Naming an S Corporation in California
Make sure that your name choice is available with the CA Sec of State.
Also take trademark law into consideration and make sure the name you would like to use is not already registered as a trademark.
Determine Who Will Serve as Agent of Service of Process
S Corporations in California are required to have an agent of service of process (also known as a registered agent).
The registered agent is responsible for receiving official documents on behalf of the entity and must be available from 9-5, daily, at a California physical address.
Failure to be present during regular business hours can result in a default judgement in case of a lawsuit.
Accordingly, it is critical that you designate someone who is available during during the required times.
The corporation’s shareholder, directors, or anyone else can serve as agent, as long as they meet the requirements.
You can also delegate responsibility to a an authorized company.
File Articles of Incorporation
Filing Articles of Incorporation with the California Secretary of State is the official first step in forming an S corporation in California.
The articles should include the name of the corporation, the business address, the agent of service of process name and address, number of shares and purpose of the corporation.
Prepare Organizational Corporate Minutes
Organizational corporate minutes document the officers and directors of the corporation and lay out other important corporation information.
It is important for S corporations to have organizational minutes in case of an audit or lawsuit.
Corporate minutes should also be prepared on an annual basis.
The operating procedures and rules of the corporation are referred to as bylaws and are created by the corporation’s directors.
Bylaws establish the corporation office location, how the corporation is operated, the time, place and manner of stockholder meetings, stock issuance, director powers, numbers, elections and indemnification, officer types, duties and meetings, record keeping and other general matters.
Bylaws are an integral part of the corporate records and should be available for review in case of a lawsuit or audit.
Failure to prepare bylaws can be used as one of many factors to “pierce the corporation veil.” This is a legal concept dictating when the corporation’s protection are disregarded and the corporation’s owners are held personally responsible for business debts and liabilities.
Issue Shares to the Shareholder(s)
Ownership should be documented by shares of stock.
Stock certificates should reference the name of the corporation, number of shares authorized, number of shares issued, shareholder name, date of issuance and should be signed by the president and secretary of the corporation.
Issuance of stock is an often overlooked and very important part of the corporation formation process.
Prepare a Stock Ledger
A stock ledger documents issuance of the S corporation’s stock.
Specifically, the ledger should enumerate the name of each stockholder, the number of shares held, how much was paid for the stock and whether any stock transfers transpire.
Obtain a Tax ID Number (TIN)
A Taxpayer Identification Number (TIN), which is also known as an Employer Identification Number (EIN) is an identifying number issued by the Internal Revenue Service for newly created corporations. An EIN can be likened to a Social Security Number (SSN) for a business.
You will need an EIN when opening your corporate bank account and filing taxes.
File IRS Form 2553
IRS Form 2553, also known as an S corporation election, needs to be filed with the IRS if you would like the corporation to be taxed as an S corporation.
The Form requires the name of the corporation, address, date of formation, EIN, representative and stockholders.
Since California is a community property state, stockholder spouse should be included on IRS Form 2553.
The filing deadline is within 75 days of incorporation.
For FAQs, see Form 2553 instructions.
File a Statement of Information
Within 90 days of formation, a Statement of Information should be filed with the California Sec. of State.
The Statement of Information should include the S corporation’s name, California Secretary of State entity number, business address, mailing address (if different), directors, officers, registered agent and type of business.
File a Limited Offering Exemption Notice
If the value of stock is less than $25,000, the filing fee is $25.
Be sure to file on time since a penalty may be assessed for late filing.
The exemption serves basically let the government know that you are not selling shares to third parties and to exempt you from further securities filings.
Open a Bank Account for the California S Corporation
Be sure you open a business bank account for the S corporation shortly after incorporation. The amount deposited in the account should be referenced on the stock ledger and organizational minutes.
Only this account should be all future financial transactions associated with the S corporation. Never use personal funds or accounts for anything related to the corporation. Doing so can create liability issues.
Obtain a Local Business License
Some cities in California require you to obtain a local business license for the purpose of paying local taxes.
Visit the CAlGold website to help determine what licenses and permits may be required for your business.
Notify Third Parties When You Form an S Corporation in California
Ensure that anyone the business deals with knows that an S corporation has been formed.
This will prevent an argument that they did know you had a corporation. In order to be afforded the protections of a corporation, everyone you deal with needs to know you are incorporated.
All documents and contracts should bear the corporation name and should be signed by an officer or director.
Consult With Your CPA
Taxes are very important when forming a new entity. Work with your accountant ensure you stay on top of all tax filing and payment deadlines.
The California Franchise Tax Board will not remind you about the $800 minimum tax payment, which starts the second calendar year of existence.
Accordingly, it important to be working with a good accountant that can keep you on top of such requirements.
Tax delinquencies can result in corporation invalidation in case of a lawsuit.
The accountant can also help with setting up payroll and registering with the California Employment Development Division (EDD).
So be sure to hire a qualified CPA shortly after the S corporation formation process is completed.
The entity must act like a corporation in order to be afforded the protection and tax savings of a corporation.
This entails submitting all annual filings on a timely basis, preparing annual minutes, filing taxes, paying taxes and more.
Make sure you file the corporation’s Statement of Information, with the California Secretary of State on an annual basis.
Remain compliant and mark your calendar.
Failure to remain compliant can lead to corporate suspension and penalties.
Comply with the Corporate Transparency Act When You Form an S Corporation in California
A historic new federal law called the Corporate Transparency Act is going into effect, sometime in 2022, which requires that corporation ownership be disclosed to the Dept. of Treasury Financial Crimes Enforcement Unit (FinCEN).
The goal of the law is to curtail tax evasion, money laundering, cyber crime, terrorism and other illegal acts facilitated by corporations and LLCs.
Violations of the Corporate Transparency Act can result in penalties that are characterized as willful are subject to a $500 per day (up to $10,000) and even prison time.
Stay tuned for updates and ensure your comply with this new law.
If you would like us to assist with formation of your S corporation, call (310) 765-2525 for a free attorney consultation or simply click here to securely get the process started.