The California tax treatment of S corps and nonresident shareholders differs sharply from the federal pass-through model. California recognizes a federal S election automatically, but it charges the corporation an $800 annual minimum franchise tax and a 1.5% entity-level tax on net income, sources each shareholder’s share of income to California under market-based rules, and requires the corporation to withhold 7% on distributions to nonresident shareholders. Those shareholders then file a California nonresident return, or join a group return, to reconcile what they actually owe.
What the S Corporation Itself Owes California
Revenue and Taxation Code Section 23800 folds the federal S corporation rules into California law with modifications, so a valid federal election is honored without a separate state filing.1California Legislative Information. California Code Revenue and Taxation Code 23800 – Tax Treatment of S Corporations and Their Shareholders Every S corporation that is incorporated, registered, or doing business in California then owes two entity-level taxes.
The first is the $800 minimum franchise tax. It applies whether the company is active, inactive, or operating at a loss, and even short-period returns of less than 12 months owe the full amount.2Franchise Tax Board. S Corporations Non-payment can lead the Franchise Tax Board to suspend the corporation’s powers, rights, and privileges in the state. Corporations newly incorporated or newly qualified to do business in California on or after January 1, 2020, skip the $800 in their first taxable year; the full amount applies from year two onward regardless of profitability.3Franchise Tax Board. Corporations
The second is the 1.5% franchise tax on net income, calculated at the entity level before income flows through to shareholders.4Franchise Tax Board. 2025 Instructions for Form 100-ES – Section: Estimated Tax and Tax Rates If 1.5% of net income comes out below $800, the corporation still pays the $800 minimum. Financial S corporations pay 3.5% instead, under a Section 23802 mechanism that adds the differential between the financial corporation rate and the general corporate rate onto the base 1.5%.
Watch-Outs for C-to-S Conversions
Two extra taxes can hit a corporation that converted from C to S status.
California’s built-in gains tax uses a ten-year recognition period rather than the five-year federal window under IRC Section 1374.5Office of the Law Revision Counsel. 26 U.S. Code 1374 – Tax Imposed on Certain Built-in Gains6California Franchise Tax Board. S Corp Handbook Chapter 5 So a conversion seven years old is clear federally but still exposed in California, and the tax applies at the general 8.84% corporate rate.
Corporations that still carry accumulated C corporation earnings and profits also owe an excess net passive income tax when more than 25% of gross receipts come from passive investment income such as rents, royalties, dividends, and interest. California conforms to the federal rule under IRC Section 1375 but applies its own corporate rate, and Revenue and Taxation Code Section 23811 limits the tax to the excess net passive income attributable to California sources.7Justia. California Revenue and Taxation Code 23800-23813 – Tax Treatment of S Corporations and Their Shareholders No credits can reduce it. Corporations that cleared out their C corporation earnings and profits before electing S status are not exposed.
How a Nonresident Shareholder’s Income Is Sourced to California
A nonresident pays California tax only on income sourced to California, not on the S corporation’s total income. Section 17951 limits a nonresident’s gross income for California purposes to income from California sources.8Justia. California Revenue and Taxation Code 17951-17955 – Gross Income of Nonresidents The shareholder can have never set foot in the state and still owe tax because the corporation’s economic activity in California flows through their ownership share.
California uses market-based sourcing. Under Section 25136, services are sourced to California to the extent the purchaser received the benefit in the state, and tangible goods are sourced to where the goods are delivered.9California Legislative Information. California Revenue and Taxation Code 25136 A software company based in Texas with California customers can generate substantial California-source income without a California office or a single California employee.
The S corporation reports each nonresident shareholder’s California-source share on Schedule K-1 (100S), with the California-source amounts appearing in column (e).10Franchise Tax Board. 2025 Shareholders Instructions for Schedule K-1 (100S) Shareholders who don’t run a business unitary with the S corporation use column (e) directly. Shareholders whose own business is unitary with the S corporation have to combine and apportion, which is complex enough that most work with a preparer.
The 7% Withholding on Nonresident Shareholders
California requires the S corporation to withhold on California-source income paid or distributed to a nonresident shareholder. Under Section 18662 and its regulations, the rate is a flat 7% of the gross payment.11Legal Information Institute. Cal. Code Regs. Tit. 18, 18662-4 – Withholding on Payments It’s a prepayment, not a final tax, and the shareholder reconciles it when they file.
To handle withholding, the corporation needs each nonresident shareholder’s legal name, Social Security number or ITIN, and current residential address. Withholding is reported on Form 592 (Resident and Nonresident Withholding Statement); pass-through entities may use Form 592-PTE instead depending on their situation.12Franchise Tax Board. 2025 Instructions for Form 592 Payments are due quarterly:
- January through March, due April 15
- April through May, due June 15
- June through August, due September 15
- September through December, due January 15 of the following year
When a due date falls on a weekend or holiday, the deadline moves to the next business day. Payment can be made electronically through FTB Web Pay or by mailing Form 592-V. The corporation then issues Form 592-B to each nonresident shareholder showing tax withheld, and the shareholder claims that amount as a credit on their California return. Excess withholding is refunded; a shortfall is paid with the return.
How the Nonresident Shareholder Files
A nonresident shareholder reports their California-source S corporation income on Form 540NR, the Nonresident or Part-Year Resident Income Tax Return.13Franchise Tax Board. California Group Nonresident Tax Return California’s progressive individual rates apply, and the top marginal rate reaches 14.4% once the mental health services surcharge is included. Because the rate is calculated based on worldwide income even though tax is imposed only on the California-source portion, even a modest California share can be taxed at a high effective rate.
The Group Nonresident Return
An S corporation with multiple nonresident shareholders can file a single group nonresident return on their behalf, using Form 540NR at the entity level with FTB 3864 attached to make the election. A shareholder qualifies only if all three of these are true:
- They are a nonresident of California for the entire taxable year.
- Their only California-source income comes from the S corporation (or from another entity filing its own group return).
- They are an individual or a grantor trust.
Shareholders included in the group return don’t file separate California personal income tax returns for that year. Shareholders with California rental income, other business income, or part-year residency cannot participate and must file individually.
The PTE Elective Tax Workaround
California’s pass-through entity elective tax lets the S corporation pay 9.3% on qualified net income at the entity level, which produces a federal deduction at the entity level that isn’t subject to the individual $10,000 SALT cap.14Franchise Tax Board. Pass-Through Entity (PTE) Elective Tax15IRS. Notice 2020-75 Shareholders then claim a nonrefundable California credit for their share of the PTE tax paid, with unused credits carrying forward up to five years.
For taxable years beginning on or after January 1, 2026, the election is made on a timely filed original or superseding return using FTB 3804, and the entity must make an initial payment by June 15 of the election year. A missed June 15 payment doesn’t kill the election, but each qualifying shareholder’s PTE credit is reduced by 12.5% of their share of the unpaid amount, which is steep enough that skipping the deadline is rarely worth it.
Penalties for Late or Missed Filings
If Form 100S isn’t filed by the original or extended due date, California charges $18 per shareholder for each month or partial month the return is late, capped at 12 months.16Franchise Tax Board. FTB Publication 1060 A 10-shareholder S corp filing six months late owes $1,080 on top of any other delinquency penalties, and the FTB applies this penalty to incomplete returns as well.
The $800 minimum franchise tax accrues interest and penalties if not paid by the original due date. And the corporation’s 7% withholding obligation under Section 18662 doesn’t relieve the nonresident shareholder of the duty to file their own Form 540NR and pay any balance owed above what was withheld. Shareholders who under-withhold, underreport, or don’t file face California’s standard late-filing and late-payment penalties in addition to interest.