California S-corp election: 2553, 1.5%, payroll
An S election can replace a $6,000 California LLC fee with a tax on profit and cut federal self-employment tax: in exchange for running payroll and following stricter ownership rules. Here is how the election works, what California charges, and when it pays off.
Who can elect
- A domestic corporation, or an LLC that elects to be taxed as a corporation (Form 2553 handles both at once for an LLC).
- No more than 100 shareholders, all of them individuals who are US citizens or residents, certain trusts, or estates: no partnerships, corporations, or nonresident aliens.
- One class of stock. Different voting rights are fine; different rights to distributions are not.
That rules out most venture-backed companies (preferred stock, institutional investors) and any company with a non-US owner.
How to elect
- File federal Form 2553 no later than 2 months and 15 days after the start of the tax year the election should take effect — March 15 for a calendar-year company already in existence, or 2 months 15 days after a new company first has shareholders, assets, or begins business. All shareholders sign.
- California follows automatically. There is no separate California election form; the FTB treats a valid federal S election as a California S election.
- Missed the deadline? Rev. Proc. 2013-30 allows late-election relief within 3 years and 75 days if you had reasonable cause and have filed consistently. Don't plan around it: relief is common but not automatic.
What California charges an S-corp
California taxes S-corps at 1.5% of net income, with an $800 minimum, on Form 100S due March 15 for calendar years. Owners also pay personal California income tax on their share of profit. A former LLC that elects S status stops paying the § 17942 gross-receipts fee: the change that makes the election attractive for high-revenue, low-margin businesses. A newly incorporated S-corp is exempt from the $800 minimum in its first taxable year, but still pays 1.5% on any income.
S-corps can also elect California's pass-through entity tax (9.3% of qualified net income, extended through 2030), which lets owners deduct state tax at the entity level for federal purposes. It adds a June 15 prepayment to the calendar.
The payroll requirement
Owners who work in the business must be paid reasonable compensation as W-2 wages before taking distributions. That means a payroll provider, federal Forms 941 and 940, W-2s, and California's EDD filings. Budget the employer share of payroll tax (7.65% of wages up to the Social Security base) plus provider fees. Taking only distributions invites the IRS to reclassify them as wages with back taxes and penalties See reasonable compensation.
When it wins
High receipts and low margins favor the S-corp at the California level: at $1.2 million of receipts and $95,000 of profit, the S-corp owes about $1,425 against the LLC's $6,800 (worked comparison). Profitable owners also save federal self-employment tax on the portion of profit taken as distributions rather than salary. High-margin businesses with modest revenue, owners unwilling to run payroll, and anyone with investors who can't hold S-corp stock should usually stay LLCs or C-corps.