California SDI Opt‑Out for S‑Corp Sole Shareholders:
How to avoid paying the tax for State Disability Insurance

California’s State Disability Insurance (SDI) is generally a mandatory employee payroll withholding and employer reporting item. However, California allows an S‑corporation’s sole shareholder to opt out of SDI coverage and SDI tax if the individual elects and is approved by the Employment Development Department (EDD). This opt‑out is referenced in the state’s Quarterly Contribution Return and Report of Wages (Continuation) (DE 9C) instructions and applies only to SDI; other California payroll items (e.g., Unemployment Insurance (UI), Employment Training Tax (ETT)) and federal employment taxes still apply where required. Below is a step‑by‑step guide grounded in official California and IRS guidance, with links to the underlying authorities. DE 9C Instructions (EDD); IRS: Paying Yourself; IRS: S corporations

Who Can Opt Out of CA SDI

• California recognizes a “Sole Shareholder” exclusion from SDI for “an individual who elects and is approved by the EDD to be excluded from SDI coverage for benefits and taxes under Section 637.1 of the California Unemployment Insurance Code (CUIC).” This category is expressly listed in the DE 9C instructions as a special SDI reporting exemption page category. DE 9C Instructions (EDD)

• The opt‑out applies specifically to SDI coverage (benefits) and SDI tax, and does not exempt wages from other California employment taxes or reporting obligations. DE 9C Instructions (EDD)

What “Opt‑Out” Means in Practice

• After EDD approval, the corporation should cease California SDI withholding for the sole shareholder and report the shareholder’s wages on a separate DE 9C page labeled “Sole Shareholder,” as instructed by EDD. The DE 9C requires separate page totals and separate grand totals for special exemptions (Religious Exemption, Sole Shareholder, Third‑Party Sick Pay) and for voluntary plan reporting—do not mix these amounts with general employee wages. DE 9C Instructions (EDD)

• All other employees remain subject to SDI unless they have a different approved exemption (e.g., EDD‑approved religious exemption) or are covered under an EDD‑approved voluntary plan, which must be reported on separate DE 9C pages per EDD instructions. DE 9C Instructions (EDD)

How to Report SDI, and the Sole Shareholder Exemption, on Quarterly Filings

• California employers file Form DE 9 (Quarterly Contribution Return and Report of Wages) and Form DE 9C (Continuation) each quarter. The DE 9C instructions remind employers to file DE 9 and DE 9C together and to report even if there is no payroll. DE 9C Instructions (EDD)

• On DE 9C, use a dedicated page marked “Sole Shareholder” for the sole shareholder’s Social Security number, name, and wages, showing $0 SDI withheld for that page (because the sole shareholder is excluded). Provide separate page totals and separate grand totals for these special pages as required by the DE 9C instructions; do not combine them with general employee totals. DE 9C Instructions (EDD)

• If a voluntary plan for disability insurance is used for some employees, mark the voluntary plan checkbox on DE 9C for those employees and report their wages separately from State Plan SDI reporting, per the instructions. DE 9C Instructions (EDD)

Critical Compliance Points

• Approval is required: The sole shareholder exclusion is not self‑effectuating. The sole shareholder must elect the exclusion and be approved by EDD before SDI withholding stops and reporting changes are made. DE 9C Instructions (EDD)

• Continue federal payroll treatment: Corporate officers are generally employees for federal tax purposes, and S‑corporation shareholders working in the business are typically treated as employees with respect to wages subject to withholding and employment taxes. Opting out of CA SDI does not alter federal classification or federal payroll tax duties (FICA, FUTA). IRS: Paying Yourself; IRS: S corporations

Practical Steps to Opt Out of CA SDI (S‑Corp Sole Shareholder)

1. Confirm sole shareholder status and eligibility: Ensure the individual is truly the sole shareholder of the S‑corporation and qualifies under CUIC § 637.1 (the EDD determines eligibility). DE 9C Instructions (EDD)

2. Elect and obtain EDD approval: Submit the required election/application to EDD and wait for formal approval. Until approval is granted, SDI withholding must continue for the sole shareholder. DE 9C Instructions (EDD)

3. Update payroll after approval:

   • Stop CA SDI withholding for the sole shareholder only.

   • Maintain SDI withholding/reporting for other employees unless they have a separate approved exemption or are in a voluntary plan. DE 9C Instructions (EDD)

4. Report correctly each quarter:

   • File DE 9 and DE 9C together.

   • Use a separate DE 9C page labeled “Sole Shareholder” to report the sole shareholder’s wages and $0 SDI withheld; provide separate page totals and separate grand totals as instructed. DE 9C Instructions (EDD)

5. Keep documentation: Retain your EDD approval and payroll records showing when SDI withholding ceased for the sole shareholder and how those wages were reported on DE 9C (separate page/grand totals), in case of audit or inquiry. DE 9C Instructions (EDD)

Key Distinctions and Common Pitfalls

• SDI opt‑out does not affect UI/ETT: The sole shareholder SDI exclusion applies only to SDI coverage/tax. UI and ETT reporting and contributions must still follow California rules—do not assume UI/ETT are waived. DE 9C Instructions (EDD)

• Voluntary plan vs. sole shareholder exclusion: A voluntary plan replaces the state SDI plan for eligible employees and requires special reporting; the sole shareholder exclusion is an individual exemption from the state SDI plan. Use the correct box and separate DE 9C pages per EDD instructions. DE 9C Instructions (EDD)

• Federal status unchanged: Even if the sole shareholder is excluded from California SDI, wages paid to corporate officers/S‑corp employees remain subject to federal employment tax rules (e.g., FICA) and must be reported accordingly. IRS: Paying Yourself; IRS: S corporations

Bottom Line
California permits an S‑corporation’s sole shareholder to opt out of SDI, but only after electing the exclusion and receiving EDD approval. Once approved, cease SDI withholding for the sole shareholder and report those wages on a separate DE 9C page labeled “Sole Shareholder,” with separate grand totals as instructed. Continue SDI for other employees (unless separately approved), and maintain full compliance with California quarterly reporting (DE 9/DE 9C) and federal payroll rules for corporate officers and S‑corp employees. DE 9C Instructions (EDD); IRS: Paying Yourself; IRS: S corporations

This essay is not tax advice. Always consult a qualified tax professional for your specific situation.