A California S-Corp is a popular business structure among entrepreneurs and small business owners in California due to its unique tax benefits and liability protections. But exactly who owns a California S-Corp?

This article seeks to shed light on this question by exploring the roles of shareholders, corporate officers, and the board of directors in owning and operating a California S-Corp. We will unpack the intricate ownership structure, the tiered management structure, the distribution of power, and the legal obligations of each role, providing clarity for existing or potential owners of an S-Corp in California.

Who Owns an S-Corp in California?

In California, an S-Corp is owned by its shareholders, who are the individuals (and in certain circumstances, the entities) that own shares of stock in the California S-Corp.

Shareholders have the Ultimate Controlling Interest in a California S-Corp

These shareholders have the ultimate controlling interest in the California S-Corp.

Corporate Officers Manage Day-to-Day Operations of California S-Corps

The day-to-day operations are typically overseen by elected corporate officers such as the President or Chief Executive Officer (CEO), the corporate Secretary, Treasurer or Chief Financial Officer (CFO), and others.

The Board of Directors Control the Direction of a California S-Corp

The corporate officers are accountable to the Board of Directors, who are elected by the shareholders of the California S-Corp. The Board of Directors has a fiduciary duty to make decisions in the best interest of the shareholders of the California S-Corp. While shareholders own the California S-Corp, they do not necessarily manage it. Instead, they exercise control by electing the Board of Directors and voting on major corporate decisions as required by the California Corporations Code, the Articles of Incorporation of the California S-Corp, or the corporate Bylaws of the California S-Corp.

What is a Shareholder of a California S-Corp?

A shareholder of a California S-Corp is an individual (or certain entity) that owns shares of stock in the California S-Corp, thereby holding an ownership interest in the California S-Corp.

Shareholders Have the Ultimate Controlling Interest in a California S-Corp

Shareholders are essentially the owners of the corporation and have the ultimate controlling interest.

Shareholders Enjoy Personal Liability Protection in a California S-Corp

Shareholders also enjoy the unique benefit of limited liability, which means their personal assets are protected and cannot be used to cover the debts, liabilities, obligations, and legal judgments against the California S-Corp.

Shareholders Elect the Board of Directors of a California S-Corp

Shareholders have the power to elect the Board of Directors, who are responsible for overseeing the overall direction of the California S-Corp and making high-level decisions for the California S-Corp. In turn, the Board of Directors appoint corporate officers to manage the day-to-day operations. Shareholders also have the right to vote on major corporate decisions, as required by the California Corporations Code, the Articles of Incorporation, or the Bylaws of the California S-Corp.

California S-Corp Shareholders Do Not Participate in Management in Their Role as Shareholders

Despite holding the ultimate power in the California S-Corp, shareholders often do not participate in the daily operations of the California S-Corp in their role as shareholders. Instead, the California S-Corp entrusts the management of the business of the California S-Corp to the corporate officers and the Board of Directors. However, shareholders in a California S-Corp retain the right to review the financial statements of the California S-Corp, attend annual meetings of shareholders, vote on critical business matters, and receive a pro rata portion of the profits of the California when distributed.

Notwithstanding the foregoing, nothing prevents a shareholder in a California S-Corp from also being a member of the Board of Directors of that California S-Corp and/or also having one or more corporate officer positions with that California S-Corp. However, it is important to note that the roles and responsibilities of a shareholder and those of a corporate officer or director are distinct the actions taken by a corporate officer or member of the Board of Directors is taken in those roles and not on account of the corporate officer or member of the Board of Directors of the California S-Corp being a shareholder in the California S-Corp.

What is the Board of Directors of a California S-Corp?

The Board of Directors of a California S-Corp is a group of individuals who are elected by the shareholders to oversee the overall direction of the California S-Corp. They are responsible for high-level strategic planning and decision-making and ensure that the California S-Corp is being run in a way that enhances shareholder value.

Responsibilities of the Board of Directors in a California S-Corp

The responsibilities of the Board of Directors of a California S-Corp includes setting the strategic direction of the California S-Corp, establishing policies for management of the California S-Corp, overseeing the activities of the corporate officers, and making significant decisions such as mergers, acquisitions, or dissolution of the California S-Corp. The members of the Board of Directors of a California S-Corp are also responsible for ensuring that the California S-Corp meets its legal and fiduciary obligations.

Fiduciary Duties of the Board of Directors in a California S-Corp

Members of the Board of Directors owe fiduciary duties to the California S-Corp and its shareholders. These duties include the Duty of Care and the Duty of Loyalty.

Duty of Care

The Duty of Care requires each member of the Board of Directors of a California S-Corp to make informed decisions. The members of the Board of Directors of a California S-Corp must act in good faith, with the degree of diligence, care, and skill that a prudent person would exercise in similar circumstances. This includes a duty to stay informed about the activities of the California S-Corp, to participate in decisions for the California S-Corp, and to do so in a way that is not negligently or recklessly uninformed.

Duty of Loyalty

The Duty of Loyalty requires each member of the Board of Directors of a California S-Corp to act in the best interest of the California S-Corp and its shareholders. This means that they must put the interests of the California S-Corp and its shareholders above their own personal interests. It prohibits self-dealing, use of corporate assets for personal benefit, and other conflicts of interest.

In fulfilling these obligations, the Board of Directors must always act in good faith with the honest belief that their actions serve the best interests of the California S-Corp and its shareholders. Breach of these duties can lead to legal liability for the members of the Board of Directors of a California S-Corp.

What are the Corporate Officers of a California S-Corp?

The Corporate Officers of a California S-Corp are individuals appointed by the Board of Directors to manage the day-to-day operations of the California S-Corp. These officers include the President or Chief Executive Officer (CEO), the Corporate Secretary, and the Treasurer or Chief Financial Officer (CFO), each having distinct duties and responsibilities.

Duties of the President or CEO of a California S-Corp

The President or CEO is the highest-ranking executive officer of a California S-Corp, responsible for making significant corporate decisions and managing the overall operations of the California S-Corp. Their duties include setting corporate strategies and objectives, coordinating with the board of directors, and ensuring that the California S-Corp complies with all relevant laws and regulations. The President or CEO is usually the face of the California S-Corp, representing the California S-Corp in dealings with governmental entities, the media, and the public.

Duties of the Corporate Secretary of a California S-Corp

The Corporate Secretary of a California S-Corp plays a key role in ensuring the smooth operation of the procedures of the Board of Directors and maintaining the records of the California S-Corp. Their responsibilities include preparing and distributing agendas for meetings of the Board of Directors, taking and maintaining meeting minutes, keeping track of shareholder records, and ensuring compliance with regulatory requirements and corporate governance practices of the California S-Corp.

Duties of the Treasurer or CFO of a California S-Corp

The Treasurer or CFO of a California S-Corp is responsible for the financial health of the California S-Corp. They manage the financial planning of the California S-Corp, keep track of cash flow, and monitor the financial performance of the California S-Corp. Other duties may include preparing financial statements, budgeting, managing investments, and ensuring that the California S-Corp complies with all financial regulations and taxation requirements, including the preparation and filing of an annual California and federal income tax return, ensuring the annual minimum franchise tax with the California Franchise Tax Board, and other taxes other than federal income taxes, such as the federal self-employment tax. Federal income taxes and self-employment taxes on the net income of the California S-Corp may also be prepared by the accountants or tax attorneys for the California S-Corp and filed with the Internal Revenue Service and other taxing authorities at the direction of the Treasurer or CFO of the California S-Corp.

Fiduciary Duties of Corporate Officers of a California S-Corp

Corporate Officers of a California S-Corp, much like the members of the Board of Directors, hold fiduciary duties to the California S-Corp and its shareholders. They are required to act in the best interests of the California S-Corp above their personal interests, to act in good faith, and to use the same level of care that a reasonable person in a similar position would use under similar circumstances.

Duty of Care

The Duty of Care refers to the obligation of corporate officers of a California S-Corp to make decisions in an informed and deliberate manner. They must exercise due diligence and prudence in managing the affairs of the California S-Corp. This means they must thoroughly review all relevant information, seek expert advice when necessary, and devote adequate time and effort to their duties. Failing to exercise proper care could lead to personal liability for losses suffered by the California S-Corp.

Duty of Loyalty

The Duty of Loyalty means corporate officers of a California S-Corp must act solely in the best interests of the California S-Corp and its shareholders. They are prohibited from using their position to promote personal interests or to benefit another party at the expense of the California S-Corp. This includes, but is not limited to, avoiding conflicts of interest, not exploiting corporate opportunities for personal gain, and maintaining the confidentiality of corporate information. Violations of this duty could also result in personal liability to the California S-Corp.

These fiduciary duties guide the actions and decisions of corporate officers, ensuring that they always work towards the wellbeing and success of the California S-Corp. Failure to uphold these responsibilities can have serious legal consequences, underscoring the importance of these core principles in the governance of a California S-Corp.

What is a California S-Corp?

A California S-Corp is a type of California Corporation that meets specific Internal Revenue Code requirements enabling it to pass income, losses, deductions, and credits through to its shareholders as an S Corporation for federal tax purposes.

S Corporation Taxation of a California S-Corp

A California S-Corp itself is not subject to federal income taxes. Instead, the shareholders report the flow-through of income and losses on their personal tax returns, and they are assessed at their individual income tax rates. This allows S Corporations such as California S-Corps to avoid double taxation on the corporate net income.

California S Corporation Treatment Does Not Otherwise Change Corporate Structure

In the context of a California S-Corp, it is treated much like any other California Corporation under California law. It is formed by filing Articles of Incorporation with the California Secretary of State and is governed by California Corporations Code. A California S-Corp is characterized by a strong legal protection to its shareholders, officers, and directors against the debts, liabilities, obligations, and legal judgments against the business of the California S-Corp.

Qualifications to Elect S Corporation Status in California

To qualify for S Corporation status in California, the California S-Corp must meet several requirements. It must be a domestic corporation, have only allowable shareholders (including individuals, certain trusts, and estates but not partnerships, corporations or non-resident alien shareholders), have no more than 100 shareholders, have only one class of stock, and not be an ineligible corporation (i.e., certain financial institutions, insurance companies, and domestic international sales corporations).

California and Federal Income Tax Status

While possessing many of the characteristics of a traditional California Corporation, the California S-Corp, with its unique pass-through tax status, provides an attractive structure for many entrepreneurs and business owners who seek limited liability protection and simplified tax procedures.

When Should a California S-Corp Be Used?

A California S-Corp should be used when business owners wish to take advantage of its unique blend of features, combining the benefits of a traditional California Corporation and a pass-through entity.

Avoiding Double Taxation with a California S-Corp

A California S-Corp is attractive for businesses with a small number of shareholders who seek to avoid double taxation. The unique tax status allows for the flow-through of income and losses to shareholders, who then report these on their personal tax returns, which can result in significant tax savings.

Distributions of Net Profits to Shareholders of a California S-Corp

A California S-Corp is also an excellent structure for businesses that are looking to distribute corporate net profits to shareholders without a second tier of taxation, as is the case in the double taxation structure of a traditional California Corporation.

Self-Employment Tax Benefits of California S-Corps

Shareholders of a California S-Corp who provide services to the California S-Corp can potentially benefit from self-employment tax savings. Unlike California Sole Proprietors, general partners in a California General Partnership or California Limited Partnership, and members of a California LLC disregarded for tax purposes or taxed as a partnership, all of whom are subject to self-employment taxes on the entire net income of the business, the net income of a California S-Corp allocated to a shareholder income can be split into two categories: wages and distributions.

Only the wages portion is subject to self-employment taxes (Social Security and Medicare) of 15.3% in addition to California and federal income tax, while the distributions are not. The wages must be fair market value and reasonable commensurate with the services of the shareholders and comparable to what other businesses would pay for similar services as permitted by the Internal Revenue Service. Strategic use of this wage-distribution split can result in significant self-employment tax savings, making the California S-Corp entity an attractive choice for many small business owners.

Where is a California S-Corp Most Frequently Used?

A California S-Corp is most frequently used in a variety of industries due to its flexible nature and advantageous tax structure.

Professional Services as a California Professional Corporation Taxed as an S Corporation

The Professional Services industry, which includes businesses such as law firms, medical practices, consulting agencies, and architecture firms, often utilize special California S-Corps known as California Professional Corporations. California Professional Corporations are California Corporations formed in compliance with the Moscone-Knox Professional Corporations Act of the California Corporations Code. Each profession has special requirements the California Professional Corporation for that specific profession must meet, and these California Professional Corporations are almost always taxed as S Corporations.

California S-Corps for Retail and Wholesale Businesses

Given the pass-through nature of California S-Corps, they are attractive to retail and wholesale businesses. The ability to avoid double taxation can be highly beneficial for these businesses, which often operate on narrow margins. A California S-Corp also avoids the California LLC Fee calculated against the gross revenue of a California Limited Liability Company regardless of its profitability. California Limited Liability Companies can pay up to $11,790 in the California LLC Fee even if operating at a net loss.

California S-Corps for Real Estate Businesses (But Not Holding Properties!)

In the real estate industry, California S-Corps are used by developers, real estate agents, and real estate brokers due to their liability protections and tax benefits. California S-Corps allow for the protection of personal assets from business debts and liabilities, which is particularly important in an industry where large amounts of capital are often at stake.

Please note that California S-Corps are not appropriate business entities are not appropriate business structures in which to own real estate, as California S-Corps do not have access to capital gains tax treatment when selling assets such as real estate.

California S-Corps for Tech Start-ups

Technology start-ups also frequently operate as California S-Corps in the early stages of business. The California S-Corp structure can offer tax benefits and liability protections that are crucial for a start-up, while also providing flexibility for future funding rounds or a potential switch to traditional double taxation “C-Corp status” in later investment rounds.

California S-Corps for Family Businesses

Family businesses often choose to operate as California S-Corps. The California S-Corp structure allows for the income or losses of the business to be passed directly through to the shareholders, who are often family members. The avoidance of double taxation and the potential for self-employment tax savings can be particularly beneficial for family businesses.

Why Choose a California S-Corp?

Choosing a California S-Corp as your business structure offers numerous advantages that are tailored to meet the needs of small to medium-sized businesses.

California S-Corp Tax Benefits

First and foremost, the primary advantage of a California S-Corp is its tax benefits. Unlike traditional California Corporations, California S-Corps are treated as pass-through entities for tax purposes. This means that the income, losses, deductions, and credits of the California S-Corp are passed directly to the shareholders who then report these on their personal income tax returns. This allows California S-Corp shareholders to avoid the double taxation experienced by traditional California Corporations, where the income is taxed once at the corporate level and again at the individual level when it is distributed to shareholders.

California S-Corp Self-Employment Tax Savings

Shareholders who provide services to the California S-Corp can potentially achieve considerable savings on self-employment taxes. The Internal Revenue Service allows the net income of a California S-Corp allocated to a shareholder to be split into wages and distributions, with only the wage portion subject to self-employment taxes. Strategic use of this wage-distribution split can result in significant self-employment tax savings, making the California S-Corp an attractive choice for many small business owners.

California S-Corp Liability Protection

California S-Corps offer shareholders limited liability protection, meaning that shareholders are not personally responsible for the debts, liabilities, obligations, and legal judgments against the California s-Corp. This is particularly beneficial in industries where large amounts of capital are involved or where liability risks are elevated.

California S-Corp Flexibility for Future Funding

California S-Corps are also a popular choice for tech start-ups due to the flexibility they offer for future funding rounds or a potential switch to traditional double taxation (C-Corp) status in later investment rounds.

California S-Corp Advantages for Family Businesses

For family businesses, the California S-Corp structure allows for the income or losses of the business to be passed directly through to the shareholders, who are often family members. The avoidance of double taxation and the potential for self-employment tax savings can be particularly beneficial for family businesses.

How are California S-Corps Formed?

Forming a California S-Corp involves a multi-step process briefly outlined in this section. An experienced corporate attorney should be consulted for the formation of a California S-Corp.

Choose a Name for the California S-Corp

Select a unique name for the California S-Corp. Name availability can be checked through the website of the California Secretary of State. The name should end with either “Incorporated”, “Inc.”, “Corporation”, to indicate corporate status, however such designation is not required (but often the lack of a corporate designator indicates the corporation is a California Nonprofit Corporation).

Draft and File Articles of Incorporation

After selecting a name, Articles of Incorporation may be drafted and filed with the California Secretary of State. The Articles of Incorporation must include basic information about the California S-Corp, such as its name, corporate purpose, and capitalization, although other information is required or advisable to include.

Appoint a California Registered Agent

California law requires all California S-Corps to have a California registered agent for service of process. The agent is a person or business that agrees to receive legal papers on behalf of a California S-Corp.

Create Corporate Bylaws

Bylaws are a required internal document that outlines how a California S-Corp will operate. Bylaws should include information about the structure of the California S-Corp, the roles of Board of Directors and corporate officers, and other legally required processes.

Issuing Share of Stock and Stock Certificates

When issuing shares of stock to founders in a California S-Corp, the issuance of shares to founders often falls under the exemption provided in California Corporations Code Section 25102(f), which requires the filing of a notice. A California S-Corp may issue stock certificates to shareholders, but may also track share ownership by book entry only.

File Statement of Information

Every California S-Corp must file a Statement of Information with the California Secretary of State within 90 days of filing the Articles of Incorporation and annually thereafter.

File Form 2553 with the Internal Revenue Service

To make an S-Corp election to elect S-Corp status, a California S-Corp must submit Form 2553 to the Internal Revenue Service. This form is used to make an election under Subchapter S of the Internal Revenue Code. The form must be completed and filed before the 16th day of the 3rd month of the tax year, or at any time during the year preceding the tax year.

Comply with Tax and Regulatory Requirements

This includes obtaining an Employer Identification Number (EIN) from the Internal Revenue Service, registering for state and local taxes, and obtaining any necessary local business license and required permits.

Ready to Start Your California S-Corp? Choose San Diego Corporate Law for Experienced Legal Support!

At San Diego Corporate Law, our experienced corporate attorneys are ready to help you harness the benefits of a California S-Corp. We provide comprehensive legal support, taking care of the drafting and filings for each step of the formation process and ensuring compliance with all local, state, and federal regulations. Do not leave your business future to chance – trust the professionals who understand the intricacies of the corporate landscape. Contact us today to start your journey towards forming a successful California S-Corp.