California S Corporation
Advantages and Disadvantages



California S Corporation Advantages and Disadvantages




S corporation status is recognized by the State of California. A separate state election from the federal election is not required.

S Corporation Definition-A corporation with 75 or fewer shareholders,that has elected and qualified for a special tax status with the Internal Revenue Service (IRS).

The main advantage associated with the S Corporation is that the income passes through to the shareholders, therefore avoiding a perceived double taxation of a C-Corporation.

Should I form a California S Corporation?

The S Corporation:

An "S Corporation" is a corporation that elects to be taxed under Subchapter S of the Internal Revenue Code (enacted in 1958 and periodically amended) and receives IRS approval of its request for Subchapter S status. As a legal entity (an artificial person), the S Corporation is separate and distinct from the corporation's owners (the stockholders).

California S Corporation
Advantages and Disadvantages

Advantages of the S Corporation:

  • The independent life of the corporation makes possible its continuation, and the relatively undisturbed continued operation of the business regardless of incapacity or death of one or more stockholders.


  • Fractional ownership shares are easily accommodated in the initial offering of stock.


  • The purchase, sale, and gifting of stock make it possible to have changes in ownership without disturbing the corporation's ability to conduct business.


  • The requirement that the corporation's finances and records be separate from the finances and records of stockholders reduces the risk of unrecognized equity liquidations.


  • With only a few exceptions, under the Subchapter S election for taxation as a partnership the S corporation pays no income taxes and corporation income or loss is passed through direct to the stockholders.


  • To the extent the corporate shield is maintained and other investments and savings of the stockholders are not at risk, the personal life of stockholders is simplified.


  • The annual meetings of stockholders and consultations with legal counsel can provide stimulus for improved communication within the stockholder group (often a family group) and can provide more comprehensive guidance for management.


  • Depending on the corporation's business record and the policies and practices of prospective lenders, access to credit and the ability to secure needed resources may be improved.


  • Earnings representing "return on investment" (interest, rental payments, etc.) are not subject to self-employment tax as long as stockholder-employees receive adequate compensation for labor and management of the business.


Disadvantages of the S Corporation:

  • Lenders may require personal guarantees from corporate officers as a condition of supplying credit, thus negating the limitation of liability.


  • Conflicts or disagreements among the stockholders may immobilize decision making.


  • Restrictions on the sale of stock and/or buy-back agreements included in the bylaws may prevent minority stockholders from being able to recover the value of their investment in the corporation.


  • Through the processes of gifting and inheritance, stock ownership can become divided among many persons who are not active in the business and they may become a voting block that does not support needs and decisions believed desirable by managing stockholders.


  • Over time, corporation paid benefits for stockholder-employees may become costly and exceed the ability of the business to pay.


  • Employment benefits such as life insurance, health insurance, and housing costs are taxable income to stockholder employees with 2 percent or more stock ownership and to employees who are directly related to persons owning 2 percent or more of the corporation stock.


  • If appreciated assets are owned by the corporation and the corporation is dissolved, significant income taxes on the appreciation amount will be generated.





California's 2012 Business Tax Climate Ranks 48th

California ranks 48th in the Tax Foundation's State Business Tax Climate Index. The Index compares the states in five areas of taxation that impact business: corporate taxes; individual income taxes; sales taxes; unemployment insurance taxes; and taxes on property, including residential and commercial property. The ranks of neighboring states are as follows: Washington (7th), Oregon (13th), Arizona (27th), Nevada (3rd) and Hawaii (35th).

Tax Freedom Day Arrives on April 16 in California

Tax Freedom Day is the day when Americans finally have earned enough money to pay off their total tax bill for the year. In 2011, California taxpayers work until April 16 to pay their total tax bill (ranked 6th highest nationally), 4 days later than national Tax Freedom Day (April 12).

California's Top Individual Income Tax Rate Is 4th Highest in the Nation

With seven brackets and a top rate of 10.55 percent for those earning over $1,000,000. California's individual income tax has the third-highest rate and one of the most highly progressive structures in the nation. In 2008, California's state-level individual income tax collections were $1,531 per person, which ranked 4th highest nationally. Since most small businesses are S Corporations, partnerships, or sole proprietorships, they pay their business taxes at the rates for individuals. That makes California's taxes on small businesses some of the most burdensome in the nation.

California's Corporate Income Tax Rate is the Highest in the West

Corporations looking to relocate, or even establish, a business in the West may shy away from California, as the state's 8.84% flat rate is the highest corporate tax rate in the West. Nationally, only 7 states have a higher top corporate tax rate than California. In 2008, state-level corporate tax collections (excluding local taxes) in California were $325 per capita, which ranked 6th highest nationally.

California's Sales Tax Rate Is Highest in the Nation

California levies an 8.25% general sales or use tax on consumers, which is the highest in the nation and above than the national median of 5.85%. Local governments are also permitted to levy another 1.5%. In 2007 combined state and local general and selective sales tax collections were $1,502 per person, which ranks 15th highest nationally. California's statewide gasoline tax stands at 46.6 cents per gallon and is the 2nd highest in the nation, while its cigarette tax stands at $0.87 per pack of twenty (31rst highest nationally). Additionally, California's general sales tax and various municipal sales taxes are levied on the sale of gasoline. The sales tax was adopted in 1933, the gasoline tax in 1923 and the cigarette tax in 1959.

Property Tax Collections Slightly Below Average

Despite Proposition 13, California ranks in the middle of the pack when the states are ranked on combined state/local property tax collections. Proposition 13 favors people who have owned the same property many years by only permitting re-evaluations at resale. As in most states, local governments in California collect far more in property taxes than the state does. California's localities collected $968.01 per capita in property taxes in fiscal year 2006, the latest year for which the Census Bureau has published state-by-state data. At the state level, California collected $62.59 per capita during FY 2006. That brought its combined state/local property taxes to $1,030.60 per capita, ranked 28th highest nationally.
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