The decision time is upon you. If you’re new to the world of business, you need to weigh your options carefully if you are to make what will be a smart business and financial decision down the line. Take your time, be patient and do your homework.
Now if you’ve already done your research, you might have more specific questions on your mind. You might be seriously considering setting up an S corp for your small business. What exactly will that mean in terms of state and federal taxes? How is an S corp taxed in California?
Does an S corp pay federal income tax?
An S corporation itself is not subject to federal income tax due to its most prominent feature: pass-through taxation. Pass-through entities are not subject to federal income tax at the corporate level. Instead, S corps are taxed at the shareholder level.
This means that, for federal tax purposes, corporate income, losses, deductions, and credits are all passed through to the shareholders who will then report income and losses on their individual tax returns. They pay the resulting taxes proportionately, in accordance with their ownership percentage, that is, profit and loss distributions are calculated in proportion with each S corp shareholder’s ownership percentage.
Does California recognize S corporations?
The State of California does recognize S corps, but S corps in California are not required to make the S corp election at the state level in order to be recognized. In other words, if you elect federal S corp status for your company, it is automatically recognized as an S corp in California.
Does S Corp pay state taxes?
The State of California does charge California S Corporation tax to S corporations. S corps are required to file Form 100S tax return if they meet the following criteria:
- Being incorporated in California
- Doing business in California
- Registered to do business in California
- Receiving California source income.
The annual minimum franchise tax is $800. Additional fees may apply.
Is my company eligible for S corp status?
In order for the IRS to recognize your S corp status, your business needs to meet the following requirements:
- Being located in the US
- Having up to 100 shareholders
- Shareholder eligibility: individuals and select trusts and estates are eligible, non-resident alien shareholders, partnerships and corporations are not
- Having a single class of stock.
Some companies are ineligible for S corp status, including financial institutions, insurance organizations.
For a company to become an S corporation, all its shareholders must sign and submit Form 2553 Election by a Small Business Corporation.
How do I elect S corp status?
You can make the S corp election after completing the following steps:
- filing Articles of Incorporation (in which you need to specify that you offer a single class of stock),
- enacting bylaws,
- issuing shares and
- holding the first meeting of shareholders.
You need to make the S corp election within 45 days of the date of incorporation. If you miss this window period, you will need to wait a whole year before you get a new opportunity and a new 45-day deadline.
How can an S corp save money on taxes?
To actually save money on taxes on account of S corp taxation, the S corp has to have enough profit left after its owner/employee has received reasonable compensation (salary). Although there is no self-employment tax (another great perk and great news for S corp shareholders) on the shareholders’ share in the business profit, the salary does not count as profit which means it is not considered pass-through income. In other words, shareholders aren’t really saving money on taxes if their profit ends up being $0 once the salary or mandatory reasonable compensation has been paid.
What costs can an S corp deduct as business expense?
It may be difficult to determine which expenses you can definitely use as deductions. The ordinary business expenses that an S corporation can deduct include rent, taxes, depreciation, advertising, interest and employee benefits.
We’ll help you keep your eyes on the prize
Now that you know how an S corp is taxed in the State of California and what having your business treated as an S corporation for tax purposes means in practical terms, it’s time to take things up a notch. Whether you’ve already reached a decision or need some additional guidance, you may want to consult the leading tax professionals in person to see what next steps you should take.
Welcome to David York’s Tax Service in sunny San Diego, where we handle everything from individual to corporate taxes and provide bookkeeping and payroll services. Whether you need us to help you form your corporation or administer it, we’ve got you covered!