When to Create an S-Corp for Your Business?
Are you building or transitioning a business in California? You may be considering structuring it as an S-corporation (S-corp). S-corps can be great businesses—but they are not the right choice for every situation. You need the proper business entity. Here, our Fremont business formation lawyer provides a comprehensive guide for when to create an S-corp in California.
What is an S-Corporation?
The California Franchise Tax Board explains that an S-corp is “a corporation that elects to be taxed as a pass-through entity.” Technically speaking, an S corp is not itself a type of business entity but rather a tax election that eligible corporations can make with the Internal Revenue Service (IRS). When a California corporation (or qualified LLC) elects S corp status, it becomes a pass-through entity for federal tax purposes. That means that profits and losses “pass through” to shareholders and are reported on their personal tax returns.
When to Create an S-Corporation in California
Choosing to operate as an S corporation can be financially advantageous—but only in the right circumstances. For it to be the best choice, you have to qualify for S-corp status and there must be tangible benefits to making the election. The S-corp structure is typically best suited for businesses that have:
- Steady profits
- All owners are U.S. citizens or green card holders and reside in U.S.
- Have overhead expenses, ie: hold inventory, lease commercial space, own valuable assets, etc. and desire tax benefits.
In California, S corps must first be formed as a corporation (or LLC) and then file Form 2553 with the IRS. Beyond that, California imposes an annual franchise tax of either $800 or 1.5 percent of net income—whichever one is greater.
Business law tip: The timing of the S corp election is important. Businesses expecting to generate substantial net income—particularly when the owner is actively working in the business—often benefit most. If your business is just launching or not yet turning a consistent profit, the costs and compliance requirements of S corp status may outweigh the tax advantages
Examples of Businesses that Work Well as S-Corps
Professional Services Firms
Accountants, architects, and marketing agencies with high profits and low overhead can use S corp status to reduce self-employment taxes.
Consulting and IT Businesses
Solo consultants or firms with a few employees may find S corp tax treatment efficient once income exceeds a certain threshold.
Marketing and Creative Agencies
These service-based businesses often generate stable revenue and have minimal overhead. For that reason, they can sometimes be ideal candidates for the tax advantages of S corp status.
Every Case is Different: Speak to a Business Formation Lawyer
While S corporation status certainly offers key tax advantages, it is not suitable for every business model. An experienced California business formation lawyer can help you weigh the pros and cons of creating an s corp based on your earnings, industry, and your long-term goals.
Contact Our California Business Attorney for S-Corps Today
Lynnette Ariathurai is a California business formation attorney with the skills and experience to handle S-corps. If you have any questions or concerns about forming an S-corp, we are here to help. Contact us today for a completely confidential, no obligation consultation. From our Fremont office, we handle S-corporation formation throughout the Bay Area.