As a new business owner, one of your most important decisions is determining what form of ownership will best meet your business needs. Selecting the best structure for your business should be a carefully planned process that is discussed with a qualified professional such as an enrolled agent, certified public accountant, or attorney who specializes in this area. In addition, as your business grows over time, you may want to evaluate if a new form of ownership should be used to achieve better results.
Corporations are a business entity formed under state civil law that is a separate legal entity owned by shareholders.
The California Corporations Code contains general provisions for the formation of many different types of corporations such as personal service corporations, benefit corporations, social purpose corporations, nonprofit corporations, and corporations for various special purposes (such as cooperative corporations). Consult an attorney, specializing in business entity matters, for advice about which type of corporation should be used for your specific business needs.
A corporation is managed by or under the direction of a board of directors, which generally determines corporate policy. Officers manage the day-to-day affairs of the corporation. Corporations issue stock to their owners (the shareholders). Shareholders, unless they are officers, do not participate in day-to-day management activities. Management structure can be altered by committees of board members and shareholder agreements. Shareholders generally are not personally liable for obligations of the corporation.
Key Features of a Corporation
- Generally, the life of the corporation is perpetual in nature.
- Generally, ownership is easily transferred through the sale of stock, and new owners can be easily added by issuing additional stock.
- It is more costly to set up and maintain than a sole proprietorship or partnership.
- The corporation must create bylaws (i.e., how the corporation will operate) that cover items such as stockholder and director meetings, the number of officers, and their responsibilities.
- To preserve the liability protection for its owners, a corporation is required to abide by numerous corporate formalities, including but not limited to the holding of annual meetings and the keeping of written minutes.
- Each year, the corporation must file a Statement of Information with the Secretary of State.
- Generally, owners (shareholders) are not liable for the corporation’s contractual debts and other obligations and creditors may only look to the corporation and the business assets for payment. However, there are some exceptions. For example, if an owner/shareholder becomes a guarantor or cosigner of a debt, they may be liable.
- A separate bank account and separate records are required.
- The corporation pays a minimum tax of $800 each taxable year.
- The California $800 minimum tax is waived on newly formed or qualified corporations filing an initial return for their first taxable year.
- The California $800 minimum tax is also waived if the corporation: 1). did not do business in California during the taxable year, and 2). the taxable year was 15 days or fewer.
How to Form Corporations
The type of corporation you form will affect the administration and operation of the corporation and the type of documents that must be filed with the Secretary of State. The Secretary of State will assign a 7-digit filing number and the date of incorporation. Keep this filing number and date for your tax records. Contact the California Secretary of State at 916.657.5448 or go to sos.ca.gov for more information.
- A separate bank account should be established for the corporation.
- A corporation formed in California, referred to as a domestic corporation, will file the appropriate Articles of Incorporation and pay a fee to the Secretary of State. When a corporation is formed somewhere other than California, referred to as a foreign corporation, it can qualify/register to transact business in California by filing the appropriate Statement and Designation by Foreign Corporation along with an official certificate that verifies the corporation exists in good standing with the country or state of its incorporation, and pay a fee to the California Secretary of State.
- A corporation must create bylaws (i.e., how the corporation will operate) that cover items such as stockholder and director meetings, the number of officers, and their responsibilities.
- The California Corporation Code requires a corporation to hold annual meetings and keep written minutes to preserve the liability shield for its owners. Note: additional corporate formalities may also be necessary to preserve liability protections. The performance or omission of certain acts may eliminate the liability shield for the shareholders. Consult with a business attorney, if necessary.
- Corporations are also required to file a Statement of Information with the California Secretary of State every year. If the Statement of Information is not timely filed, the corporation may be subject to penalties and/or may be suspended. Contact the California Secretary of State at 916.657.5448 or go to sos.ca.gov for more information.
- Most cities and counties require a business license, various permits, and/or registration to do business within their city or county limits. If you are doing business in multiple cities or counties, you may be required to have multiple licenses. Contact the business licensing department of the city and/or county directly where your business will primarily be located for specific rules and regulations. The Governor’s CalGold online database at calgold.ca.gov, the Governor’s Office of Business and Economic Development (GO-Biz) at business.ca.gov, and the California Business Portal at businessportal.ca.gov all provide links and contact information to agencies that administer and issue business licenses, permits, and registration requirements from all levels of government.
- Contact your local Chamber of Commerce or call the statewide Chamber of Commerce at 800.331.8877 for information for your area and referrals to other agencies.
- If required, register a fictitious name, also referred to as “Doing Business As” or DBA. Refer to Appendix 1 in this booklet for more information.
Personal Service Corporation
A personal service corporation is a type of corporation whose principal business activity is the performance of personal services and such services are performed by employee-owners. Individuals who perform services in fields such as health, law, engineering, architecture, performing arts, and accounting typically use this classification.
A corporation is a personal service corporation if it meets all of the following requirements:
- Its principal activity during the testing period is performing personal services. Personal services include any activity performed in the fields of accounting, actuarial science, architecture, consulting, engineering, health (including veterinary services), law, and the performing arts. Generally, the testing period for any tax year is the prior tax year. If the corporation has just been formed, the testing period begins on the first day of its tax year and ends on the earlier of: a). The last day of its tax year, or b). The last day of the calendar year in which its tax year begins.
- Its employee-owners substantially perform the personal services. This requirement is met if more than 20 percent of the corporation’s compensation cost for its activities of performing personal services during the testing period is for personal services performed by employee-owners.
- Its employee-owners own more than 10 percent of the fair market value of its outstanding stock on the last day of the testing period.
A person is an employee-owner of a personal service corporation if both of the following apply:
- The individual is an employee of the corporation or performs personal services for, or on behalf of, the corporation (even if the individual is an independent contractor for other purposes) on any day of the testing period.
- The individual owns any stock in the corporation at any time during the testing period.
A benefit corporation is a new type of corporation that voluntarily meets higher standards of corporate purpose, accountability, and transparency. A corporation is a benefit corporation if it meets all of the following requirements:
- It has a corporate purpose to create a general public benefit or a material positive impact on society and the environment.
- It is required to provide greater protection to its officers and directors to pursue objectives that benefit society, the environment, and the corporation’s employees.
- It is required to make available to the public an annual benefit report that assesses their overall social and environmental performance against a third party standard.
Social Purpose Corporation
A social purpose corporation (SPC) is very similar to a benefit corporation in its standards and requirements. There is a slight difference in its accountability and reporting requirements as an SPC does not have an independent third party standard to assess the company’s social and environmental performance.
More information on both benefit corporations and SPCs is available at sos.ca.gov and ftb.ca.gov.
A nonprofit corporation is a corporation that is formed to carry out charitable, educational, religious, literary, scientific, social, or other similar purposes. They are formed pursuant to the Nonprofit Corporation Law in the California Corporations Code. A nonprofit corporation does not pay federal or state income taxes on profits from activities it engages in to carry out its objectives if it is tax-exempt. In order to qualify for this special tax-exempt status, it must apply for it with the Internal Revenue Service and the Franchise Tax Board. More information on nonprofit corporations is available at sos.ca.gov, ftb.ca.gov, and FTB PUB 927, Introduction to Tax-Exempt Status.
Tax Return Filing Guidelines for a Corporation
Corporations are normally taxed under Internal Revenue Code, Subtitle A, Chapter 1, Subchapter C. Corporations taxed following the Subchapter C rules are more commonly known as “C corporations.” They are taxed annually on their earnings and the shareholders pay tax on these earnings when distributed as dividends.
The California Revenue and Taxation code requires a C corporation to be subject to the $800 minimum franchise tax if it is incorporated or organized in the state (domestic corporations); qualified or registered to do business in the state (foreign corporations); or doing business in the state without having incorporated, organized, or registered/qualified.
Tax Return Filing Guidelines for a C Corporation
- C corporations that organize in California, register in California, conduct business in California, or receive California source income must file California Form 100, California Corporation Franchise or Income Tax Return.
- The C corporation’s return due date is the 15th day of the 4th month after the close of the taxable year.
- C corporations are taxed on their net income at a rate of 8.84 percent by California.
- C corporations are subject to a California minimum tax of $800.
- The California $800 minimum franchise tax is due the first quarter of each accounting period and must be paid whether the corporation is active, inactive, operates at a loss, or files a return for a short period of less than 12 months.
- The California $800 minimum tax is waived on newly formed or qualified corporations filing an initial return for their first taxable year. The California $800 minimum tax is also waived if the corporation (1) did not do business in California during the taxable year, and (2) the taxable year was 15 days or fewer.
Estimated Tax for a C Corporation
California taxes are pay-as-you-go, so C corporations may have to make estimated tax payments for their own reporting purposes.
- The C corporations estimated tax is due and payable in four installments on April 15, June 15, September 15, and December 15.
- C corporations complete and file California Form 100-ES, Corporation Estimated Tax to report their estimated taxes. (For more information and applicable rates, go to ftb.ca.gov/forms, and search for 100-ES.)
- The California $800 minimum franchise tax is due the first quarter of the C corporation’s accounting period and must be paid whether the corporation is active, inactive, operates at a loss, or files a return for a short period of less than 12 months.
Tax Return Filing Guidelines for an S Corporation
Corporations formed under state civil law (and other civil law business entities classified as a corporation for franchise/income tax purposes) may elect to be taxable as an “S corporation” for franchise and income tax purposes pursuant to the provisions of Internal Revenue Code, Subtitle A, Chapter 1, Subchapter S. A corporation makes the election to be taxable as an S corporation by filing IRS Form 2553, Election by a Small Business Corporation with the IRS. An entity that has a valid S corporation election in effect for federal income tax purposes is treated as an S corporation for California income/franchise tax purposes.
An S corporation is not subject to federal corporate income tax, with several exceptions. An S corporation is subject to federal income tax on excess net passive investment income. Also, an S corporation that was previously a C corporation is also subject to federal income tax on built-in gains recognized during the “recognition period” following the S election. Except for these limited cases where the S corporation is subject to federal income tax, the S corporation is a “pass-through entity” similar to an entity taxable as a partnership. Items of income, gain, deduction, and credit pass through to the S corporation’s shareholder(s) on a pro rata ownership basis. These S corporation items are included in the federal income of the shareholder(s), subject to provisions that limit the pass-through of losses and deductions, for purposes of determining a shareholder’s federal income tax.
California generally applies the federal income tax rules to S corporations. However, California differs from federal tax law by also imposing a general corporate franchise or income tax on S corporations, but at a tax rate of only 1.5 percent (3.5 percent for financial S corporations).
Key tax features of an S corporation include:
- The number of shareholders may not exceed 100.
- The corporation can have only one class of stock.
- Ownership is generally limited to individuals who are U.S. citizens or residents, certain tax-exempt entities, and certain types of trusts. Partnerships, corporations (other than certain tax-exempt corporations), and nonresident alien individuals are not allowed as shareholders.
- An entity elects to be an S corporation by filing Form 2553 with the IRS. An entity that is an S corporation for federal purposes is an S corporation for California purposes.
- Detailed rules apply to the timing and other requirements for making and revoking a valid election to be taxable as an S corporation, and for what causes a termination of an election.
- An S corporation generally does not pay federal income tax, with exceptions for tax on excess net passive investment income and on certain built-in gains.
- Under California law, the S corporation is subject to a 1.5 percent tax on its net income (3.5 percent for financial corporations).
- The items of income, deductions, and credits flow through from the S corporation to each shareholder through the Schedule K-1 (IRS 1120S/FTB 100S), Shareholder’s Share of Income, Deductions, Credits, etc. Each shareholder is responsible for paying taxes on their pro rata share of the S corporation’s items of income, deductions, and credits even if they are not actually distributed.
An entity taxable as an S corporation that organizes in California, registers in California, does business in California, or receives California source income must file Form 100S, California S Corporation Franchise or Income Tax Return.
The return due date is the 15th day of the 3rd month after the close of the taxable year.
S corporations are subject to the $800 minimum California franchise tax. The California $800 minimum tax is waived on newly formed or qualified corporations filing an initial return for their first taxable year. The California $800 minimum tax is also waived if the corporation (1) did not do business in California during the taxable year, and (2) the taxable year was 15 days or less.
The S corporation must provide each shareholder with a Schedule K-1 (IRS 1120S/FTB 100S) that states the shareholder’s pro rata share of the S corporation’s items of income, deductions, and credits even if no income is actually distributed.
Taxpayers that desire to do business as an S corporation should seek professional tax advice.
Estimated Tax for an S Corporation
California taxes are pay-as-you-go. Therefore, S corporations and their shareholders may have to make estimated tax payments for their own separate reporting purposes.
- The S corporation’s estimated tax is due and payable in four installments on April 15, June 15, September 15, and December 15.
- S corporations complete and file California Form 100-ES, Corporation Estimated Tax to report their estimated taxes. (For more information and applicable rates, go to ftb.ca.gov/forms, and search for 100-ES.)
- The California $800 minimum franchise tax is due the first quarter of the S corporation’s accounting period and must be paid whether the corporation is active, inactive, operates at a loss, or files a return for a short period of less than 12 months.
- An individual shareholder’s estimated tax installment payments are due and payable on April 15, June 15, September 15 of the taxable year, and January 15 of the following taxable year.
- Individual shareholders complete California Form 540-ES, Estimated Tax for Individuals to report their estimated taxes.
- Generally, you must make estimated tax payments if you expect to owe at least $500 ($250 if married/RDP filing separately) in tax for the current year (after subtracting withholding and credits) and you expect your withholding and credits to be less than the smaller of: 1). 90 percent of the tax shown on your current tax return; or 2). 100 percent of the tax shown on your prior year tax return including Alternative Minimum Tax (AMT).
- Each shareholder is responsible for paying taxes on his/her pro rata share of S corporation income even if no money or property is actually distributed to the shareholders.
How to End a Corporation
- File California Form 100 or Form 100S for the last taxable year, check the box that indicates that it is a final return, and write “Final” on top of the return.
- File California Form 100 or Form 100S for all delinquent tax years.
- Pay all outstanding tax liabilities, interest, and penalties.
- Domestic corporations file the appropriate Certificate of Election to Wind Up and Dissolve, with the California Secretary of State.
- Foreign corporations file the appropriate Certificate of Surrender of Right to Transact Intrastate Business with the California Secretary of State.
- Notify all creditors, vendors, suppliers, clients, and employees of your intent to go out of business.
- Close out business checking account and credit cards.
- Cancel any licenses, permits, and fictitious business names.
- Consider publishing a statement in a local newspaper of general circulation near the principal place of business that the corporation is no longer in business.
- Refer to FTB PUB 1038, Guide to Dissolve, Surrender, or Cancel a California Business Entity for more information on how to dissolve a corporation.
The Shareholders, Officers and Directors are protected in a corporation from the acts of other Employees, Shareholders, Officers and Directors of the corporation by what is commonly referred to as the Corporate Veil. The corporation is a great entity to receive tax benefits and protection from the corporate veil, but is also a perfect entity to run a business. It is not very good to hold assets that you would want to be protected. A Limited Partnership of out of state LLC would be a better fit for that need. Many use a Corporation to run their business, ie a care home business, but have an FLP (Family Limited Partnership) or out of state LLC (Limited Liability Company) to own the home or property where the care home business is run.
The process of setting up corporations may seem daunting… but, it doesn’t have to be.