How To Form A California Corporation And S-Corporation
A Corporation with an S-Corp election (an “S-Corp”) is a state corporation which has elected with the IRS to be taxed as an S-Corporation. It may be ideal for a business operated solely by a single shareholder-employee (due to significant tax savings by avoiding Self-Employment Taxes). Independent contractors are a great example.
The following guide lays out how to form an S-Corp in California (corporation formed in California with an IRS S-Corp election) – but it has general guiding applicability in other states (do not worry we will get to them all!). Please consult your tax advisor for instructions on how to reap the full tax benefits of being an S-Corp.
See the full interactive guide and download all the necessary documents at our alpha application.
- Decide that you want to form an S-Corporation (“S-Corp”) (see Choosing Your Business Entity)
I. FORMING YOUR CALIFORNIA S-CORP
1. Select a Name For Your Company
- What is it? In order to choose a name for your California S-Corp (“CA S-Corp”) the name must be available.
- What to do? This process is somewhat painful because of the technological incompetence of the CA Secretary of State (“CA SOS”). One can mail in a Name Check Form to the CA SOS to see if the name is available (there is no electronic submission as of yet). This can take up to 2 weeks. Alternatively you can do a general name search online to see if someone is using your proposed name. This is also valuable for Trademark purposes, so it might be worthwhile.
2. Create and File Articles of Incorporation (“AOI”)
- What is it? A document which lays out the primary information and rules of your corporation. It is also referred to as a “charter” for your corporation. In order to create a CA Corporation your first step is to file a AOI with the CA SOS. Filing this form will only register the Corporation with the state. In order to properly form the corporation the incorporator must then adopt bylaws, elect a board and officers and distribute shares (as seen below). After the corporation has been successfully formed. The S-Corp election must be made with a separate filing as explained below.
- What to do? Draft your AOI with the CA standard form or a personally drafted AOI. California allows corporations to incorporation with no par value, but many attorneys would suggest setting the par value. Mail 3 Copies of your AOI with a check for $100.00 to: Secretary of State Business Entities, P.O. Box 944260 Sacramento, CA 94244-2600
3. Check To See That Your Corporation Has Been Formed
- What is it? Before you proceed with anything below, your business must be properly registered as a Corporation with CA.
- What to do? Wait to receive confirmation from the CA SOS via mail, or call their office at (916) – 657 – 5448 (hit 2, then 1, then 1, then 0) to see if you AOI have been filed.
4. File IRS Form 2553 (S-Corp Election)
- What is it? The form that one must file with the IRS to be treated like an S-Corp for tax purposes. There are some timing restrictions for when you file your S-Corp so confer with your tax advisor on when to file your Form 2553. Generally, you should make your S-Corp election within 3 months of creating your S-Corp.
- What to do?
- Complete Form 2553 and print it out.
- Mail to: Department of the Treasury Internal Revenue Service Center Ogden, UT 84201
- OR Fax to: (801) 620-7116
5. Incorporator’s Organizational Action
- What is it? CA allows the incorporator of the company to set up the entire corporation with an Incorporator Organizational Action (“Action”). The incorporator can approve the sale of stock, establish the bylaws of the company, establish the board, put in place the officers and many other things. If you are a single owner, then this should be relatively straight forward since you will not need to decide on any equity splits or director seats with other co-founders.
- What to do? Draft the Action (see an example below), have them reviewed by a lawyer along with the bylaws below, have the incorporator sign them and then internally file the Action
- Example Document: Sample Incorporator’s Organizational Action
6. Bylaws (Adopted in Action by Incorporator)
- What is it? Bylaws are the the rules which govern the operations of the company.
- What to do? Draft and internally file.
- Example Document: Sample California Bylaws
7. Get An Employee Identification Number (“EIN”) And Set Up Bank Accounts
- What is it? Your EIN is really your federal tax number and the way the IRS keeps track of you . . . darn taxes!! You need an EIN to open a business bank account.
- What to do? Go to the IRS EIN website to get your EIN in less than 5 minutes. It is 100% free so do not pay anyone to do this.
8. Stock Purchase Agreement
- What is this? A stock purchase agreement is the instrument that allows a founder to purchase shares from the company and lays out the terms governing the purchase – including the rights of the shareholders (can sometimes be found in a separate shareholder rights agreement). Many attorneys agree that the best way to distribute shares in the company (and reduce any tax liability) is simply through purchasing their shares. The sale of shares can be authorized in the Incorporators Organizational Action above.
- What to do? See whether you need to include vesting in your Stock Purchase Agreement. Some founders can have vesting while others do not depending on the situation. Have each founder who is purchasing stock sign a stock purchase agreement. For any stock purchased, each founder will need to write a check, sign it, scan it, put the scan into the company records.
- Example Document:
- Stock Purchase Agreement With No Vesting (Single Founder)
- Stock Purchase Agreement With Vesting (Multiple Co-Founders)
9. All Founders Assign Their Past Intellectual Property Relevant To The Company
- What is it? It is critical that each of the founders assign any IP related to the startup’s business to the company. Some attorneys prefer merely assigning the IP to the company for “fair consideration.”
- What to do? If there is IP to be assigned, then place IP Assignment provisions in your Stock Purchase Agreement or create a separate IP Contribution Agreement for the founders who wish to assign IP to the company. You should consult your attorney for putting these into place. Each founder will sign an agreement and a copy will be internally filed with the company.
- Example Document: Intellectual Property Assignment Agreement (Coming Soon)
10. Record Any Assigned Patents and Trademarks With The United States Patent and Trademark Office (as applicable)
11. All Founders Sign A Confidential Information & Invention Assignment Agreement (“CIIA”)
- What is it? A CIIA primarily assigns to the company any future intellectual property related to the company developed by an individual founder while that founder is at the company. It is a common practice for all founders, officers, managers, employees and consultants to enter into a CIIA.
- What to do? Each founder will sign an agreement and a copy will be internally filed with the company.
- Example Document: Confidential Information & Invention Assignment Agreement (California)
12. Stock Certificates
- What is it? A Stock Certificate is a physical representation of a stockholder’s shares.
- What to do? This depends on your agreements, but typically, if the shares are subject to vesting, then after the certificates are created they will be kept in escrow by the company. If a founder’s shares are not subject to vesting, then the company should create and present the founder with the Certificate.
- Example Document: Stock Certificate
13. State Securities Exemption Notice (25102(f) in California)
- What is it? Founders are actually subject to both federal and state security filing exemptions. In California 25102(f) grants exemption from securities qualification for certain limited securities offerings. The startup which sells the shares to the founder MUST FILE A 25102(f) EXEMPTION NOTICE with the California Department of Corporations for an in or out-of-state corporation. Check your individual state’s security filing exemptions.
- What to do? The 25102(f) notice must be filed with the state within 15 calendar days after the first sale of a securities. Startups must file the 25102(f) Limited Offering Exemption Notice electronically, via the California Department of Corporations website. The filing fee for a startup is typically $25.00.
- Link to Online Filing: California 25102(f) Notice
14. 83(b) Elections For Vesting Stock – Within 30 days of stock purchase!!
- What is it? 83(b) elections have several CRITICAL tax implications which you should look into further with your tax professional. Generally, 83(b) elections are used is the cases of founder stock with vesting attached to it.
- What to do? Consult your attorney and tax advisor before proceeding. An 83(b) election must be completed and mailed within 30 days of sale of founder stock. Send by Certified Mailto:
Department of the Treasury Internal Revenue Service Fresno, CA 93888-000
- Example Document: Form of 83(b) Election.
15. Indemnification Agreement for Officers and Directors
- What is it? Indemnification agreements are often provided to a Company’s directors and officers to minimize potential personal liability for actions taken in their capacity as directors and officers.
- What to do? Have your shareholders approve a “Form of Indemnification Agreement.” Once it is approved, complete an Indemnification Agreement for each officer, have them signed, and file the agreements in the company’s file.
16. Statement of Information (Annually file)
- What is it? California law requires corporations, limited liability companies and common interest development associations to update the records of the company with the California Secretary of State on an annual basis by filing a statement of information. Its just another way for California to take money from its small businesses.
- What to do? A Statement of Information can be filed online and runs about $25.00.
17. Get General Business Insurance
II. Owner/Employee Tax And Employment Considerations.
Shareholders of S-Corporations do not pay Self-Employment Tax if they are actively engaged as a shareholder-employee of the S-Corp. You will, however, need to treat you, the employee, as a separate person. You need to do all the proper paperwork: New Hire Reporting, I-9, W-4, etc. You need to register the S-corp as an employer, get all the forms and all the rates (unemployment, worker comp).
Once your company starts to make income and you start to take money out, shareholder-employees must be paid a “reasonable” salary, with their wages reported on a W-2 and with Social Security and Medicare taxes already withheld (what is a reasonable salary?). Shareholder-employees will receive two tax documents from the S-Corp: a W-2 wage statement and a Schedule K-1 statement.
You should consult with a payroll professional and your accountant for the best way to handle this.
The contents of this page is not legal advice and is not a substitute for professional legal advice. Under no circumstances does the content contained herein create an attorney-client relationship nor is it a solicitation to offer legal advice. If you ignore this warning and convey confidential information in a private message or comment, there is no duty to keep that information confidential or forego representation adverse to your interests. Seek the advice of a licensed attorney in the proper jurisdiction before taking any action that may affect your rights.
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