S corporations, or S corps, are an Internal Revenue Service (IRS) tax designation that is often confused as a business entity. Instead, it is an option that certain business entities (namely LLCs and corporations) are free to elect by submitting Form 2553 to the IRS. As such, it is recommended for businesses to start an S corp by forming themselves as an LLC first and electing this tax status.
As the home to the tech hub of Silicon Valley, California is an incredibly popular haven for startups, with the highest percentage of people forming their own businesses in the country. Since business formation varies in each state, entrepreneurs interested in establishing their S corp in this state will need to be aware of the specific Californian regulations that control this area. This article will provide a brief overview of the steps to starting an S corp in California.
Considerations Before Switching
LLCs elect S corp tax status so that owners can be recognized as ’employees’, thus reducing the business’s tax burden by eliminating the need to pay self-employment tax on any distributions. However, becoming an S corp is not always in a business’s best interest, as it has several inherent restrictions and only provides these tax savings if certain conditions are met.
Namely, S corps cannot have in excess of 100 shareholders, who must be of US nationality or permanent residents in the country.
Steps To Forming An S Corp
Name Your LLC
As in most states, the process of forming a company starts with choosing its name. In California, there are several requirements that must be abided by when settling on the LLCs name. Some of the most important of these regulations include the need for the phrase “limited liability company” (or any of its variants such as LLC, etc.) to be included in the company’s name.
Additionally, the name should not contain any words or phrases that would render it possible to confuse with any of the government’s agencies. The name cannot include any of these words: trust, trustee, incorporated, inc., bank, corporation, or corp. Finally, it must be completely unique. This means that it must be sufficiently distinct from all other registered businesses in the state – the names of which can be checked online.
Choose an RA
A registered agent (RA) is a party that businesses in California are required to hire to accept tax documents and legal notices on the company’s behalf. This party must also be included in the company’s Articles of Organization.
RAs can be individuals or businesses, and it is in fact very common for business owners to hire businesses that specialize in providing RA services. Such businesses will also very often handle the complete process of forming an LLC for only a small fee.
File Articles of Organization in California
A company’s Articles of Organization is the document that officially registers it as an LLC in the state of California. It can be submitted online to the California Secretary of State, or Form LLC-1 can be filed by mail or in person. This process costs $70, which is payable to the Secretary of State and nonrefundable.
Create Operating Agreement
The next step in the formation of an LLC is the need to create an Operating Agreement. This legal document is designed to provide a delineation of the duties of each of the LLC’s members on top of their ownership rights, among other topics. There are many free operating agreement tools available online for businesses to take advantage of.
File EIN and Form 2553
The final step involves applying for an Employer Identification Number (EIN) with the IRS. This is the corporate equivalent of a social security number and allows the IRS to identify the business for taxation. Once this is done, a URL to the Election By a Small Business form (Form 2553) will be provided.
This form is used to elect S corp tax status for a business; Its completion concurrently marks the completion of your new S corp’s formation process
Clearly, starting an s corp in California is quite a complicated process, but hopefully, with the help of this article and online businesses providing LLC formation services, you will be able to thrive.