LLCs And California’s State Disability Insurance (SDI)

If you are forming a California S Corp, it is often preferred to use a C corporation or professional corporation (PC) as the underlying entity, or convert to one if you already have an LLC. Why? When you pay a reasonable salary to the shareholders, they must pay into California’s State Disability Insurance (SDI) plan through payroll withholding. Since January 1, 2024, there is no wage cap on SDI, so the rate (1.3% for the 2026 tax year) hits every dollar of salary. A $150,000 salary costs $1,950 a year and a $300,000 salary costs $3,900. Yuck!

For licensed professionals who want to operate through an entity, California often makes the choice for you. California does not allow an LLC to render professional services at all (Cal. Corp. Code Section 17701.04(e)), so there is no California PLLC. The PC comes in flavors under the Moscone-Knox Professional Corporation Act: a physician forms a medical corporation, a dentist a dental corporation, and a nurse (RN, NP or CRNA) a nursing corporation under Business and Professions Code Section 2775, each with its own naming rules and licensing board. If you are a 1099 nurse or CRNA working in California and want an entity, the nursing corporation is generally your route. Attorneys, accountants, architects, engineers and land surveyors also get the LLP option.

However, a corporate officer who is the sole shareholder (or the only shareholder other than a spouse who is also an officer) can opt out of SDI under California Unemployment Insurance Code Section 637.1 by filing Form DE 459 with the Employment Development Department (EDD). But! LLCs do not have officers; they have managers and members. As you will learn in this book, when invoking the S Corp election, the underlying entity does not change. Ergo, the EDD’s stated position (Information Sheet DE 231LLC) is that the Section 637.1 exclusion does not apply to an LLC taxed as a corporation, and an LLC taxed as an S corporation in California cannot opt out of SDI. More yuck!

Some fine print on the opt-out-

• The exclusion is SDI only; unemployment insurance (UI) and the employment training tax (ETT) still apply to your wages.
• It takes effect in the calendar quarter the form is filed, so file in early January rather than discovering it in November.
• You are giving up state disability and Paid Family Leave benefits, which matters if you do not carry private disability coverage.
• Two unrelated owners in the same corporation are out of luck since neither is the sole shareholder. Each would need their own corporation, which is one small reason the tiered entity arrangements in Chapter 2, where each owner has their own S Corp, look the way they do.