Today I am going to explain to you the difference of a California LLC vs California S Corp.
This article will help you decide which one is better your you.
As a business lawyer, I’ve assisted more than 1000’s of entrepreneurs like you start their California business without dealing with complicated legal forms, and I’m the only business lawyer whose service is backed by more than 1,000 5.0 Star Google Reviews.
Now let’s begin!
By the time you are done reading this, you should be able to determine whether you should form a California LLC or an S-Corporation (S-Corp) in California.
What is a California LLC and S-Corporations? Why should I Have One?
LLCs and S-Corporations are two very popular types of legal entities.
Before we begin deciding which is right for you let’s discuss what they are and why you should have a legal entity for your business.
A legal entity is an individual, company, or organization that can legally enter into contracts with another legal entity.
Creating a legal entity is sort of like creating a person that is separate from yourself. After you create it, the entity can enter into contracts with others, sue others, be sued, file taxes and much more.
Overall, a legal entity is something that has the capacity to function in the same way that an individual can.
So Why Should I Have a California Legal Entity?
The main benefit of a California legal entity is that it will help protect your personal assets.
When a legal entity is sued or has creditors going after it, the individuals’ assets generally cannot be taken to satisfy the debt or judgment.
This means that if your business is sued or a creditor is going after it, then the collector can only go after the business checking account and the business assets. Your personal assets such as your house, car, jewelry, bank account, and any other assets cannot be taken from you.
This is one of the main benefits of a legal entity and is the reason why so many entrepreneurs form legal entities for their businesses.
If you are not convinced that putting your business into a legal entity is smart, then email at firstname.lastname@example.org and I will share some horror stories with you!
Selecting the Right California Business Entity
I hope I have convinced you why you should have a business entity and not operate as a sole proprietor.
Now I will explain to you the importance of choosing the right business entity.
When forming a company choosing the right business entity is crucial because of the far-reaching legal and tax consequences.
Choosing the right entity will require you to really think about what your plans are for the future of your company.
Factors such as the amount of money you anticipate making and whether you plan on raising money are two very important factors to consider.
For example, if you are just creating the company to bring in some extra cash on the side and you do not plan on getting investments, then it likely will not be beneficial for you to form a corporation due to its complexities and costs.
However, if you envision that your business is going to generate a great deal of revenue and will require investments from outside sources, then forming a corporation will be important.
Overall, the decision rests on the different tax obligations associated with each business entity and whether you plan on raising funds from investors.
Both business types protect the assets of the business owner and provide different levels of tax advantages, protection of personal assets, and yearly maintenance.
Don’t worry! I am going to tell you a little bit about the two most popular business entities below.
What are the Pros and Cons of a California LLC?
Like all business entities, an LLC is legally separate from its owners, who are known as “members” of the LLC. An LLC can have one member or multiple members.
Pros of a California LLC
There are several advantages to forming a California LLC and you should carefully consider all of the pros and cons mentioned below!
Pro #1: A California LLC Provides You With Limited Liability
As mentioned above, an LLC is a business entity and the main reason people love forming LLCs is because of the protection that it provides to the business owner from creditors and judgments.
If someone gets hurt by your product, that person will likely only be able to go after the business assets rather than your personal assets.
Keep in mind, these protections also apply to S-Corps so don’t let this pro sell you on LLCs.
Pro #2: A California LLC is Easier to Form and Maintain
LLCs are also popular because they are easier to form and maintain than corporations. See our article on how to form an LLC here.
Corporations are more expensive to create, have more corporate formalities, and require more maintenance each year.
LLCs only require that you file the annual report and pay the fee, have an annual meeting, keep minutes, and file your yearly taxes.
Pro #3: A California LLC Has a More Flexible Tax Structure
Unlike S-Corporations, LLCs can choose how they want to be taxed. Often times entrepreneurs will choose to have the LLCs income pass through to their own personal income and pay the self-employment taxes.
Pro #4: A California LLC Can Have Any Number of Members
An LLC can have 1 member or several members.
There is no restriction on the number of partners that you have when you start your LLC.
S-Corps, on the other hand, are limited to having 100 owners.
Overall, there are several Pros to having an LLC and often times they really are the best option for our entrepreneurs.
Cons of a California LLC
Despite the several benefits of having an LLC, there are also some downsides.
Con #1: A California LLC Has High Formation Costs and Annual Fees
Of course, it is not free to file for an LLC. Each state charges a different amount and the annual fees vary a great deal. For example, in Wyoming, the annual fee is $50 and in California, the annual fee is a minimum of $800.
It is important to take these fees into consideration when determining where you should file for your LLC.
However, generally, it is best to form in your own state. This article does a fantastic job explaining why you should form an LLC in your own state.
Con #2: A California LLC Subjects you to Self-Employment and Excise Taxes
As mentioned above, when you own an LLC you will oftentimes be subject to paying self-employment tax which is around 7.5%.
It is important to note, however, that the owner of the LLC can elect S-status to avoid having to pay this 7.5% self-employment tax.
Con #3: A California LLC Makes it Difficult to Raise Outside Capital
A major downside to LLCs is that it will be hard to raise money for your business.
If you intend to raise money from outside investors, then it will be very difficult if you have an LLC.
Investors do not like investing in LLCs because an LLC does not have shares. The only way for an investor to invest is if you make him a member of the LLC and give him equity.
So overall, if you plan on raising capital, it is best to go with a corporation.
Often times, our entrepreneurs will start out as LLCs and then realize that they need to raise money and then need to switch to a corporate structure down the road.
What are the Pros and Cons of a California S-Corp?
An S-Corporation (S-Corp) is a corporation that has elected “S” status by filing Form 2553 with the IRS so that the owners can avoid having to pay tax at the corporate level and then again when it is distributed to the shareholders.
This can save you a great deal of money on your taxes.
However, an S-Corp still has pros and cons that are different than an LLCs.
It is important to balance the pros and cons of each entity and then make a calculated decision.
Pros of a California S-Corporation
Pro #1: A California S-Corporation Has Pass-Through Taxation
An S-Corporation is a corporation that has its profits and losses pass through to the owner’s personal income tax.
This is like an LLC where the owner can pass the income straight to his personal income rather than having to pay tax at the corporate level and then again on a personal level.
An owner of a regular C-Corporation will have to pay tax two times. Once at the corporate level and again when the income is received by the owner.
Pro #2: A California S-Corporation is More Attractive to Investors
One of the most popular reasons our clients will choose a corporate structure instead of an LLC is because it is more attractive to investors.
S-Corps can sell shares of the company’s stock to raise capital. This provides you with more opportunities to raise money from investors by selling shares of your business.
With an LLC the ability to raise money is greatly hindered because an LLC does not have shares.
Read the California S-Corporation cons below to see why an S-Corp is also not the best option if you are trying to raise money from non-US residents.
Pro #3: A California S-Corporation Provides You With Limited Liability
As mentioned above an S-Corporation is legally separate from its owners just like an LLC and provides the owners with protection from judgments and creditors.
Shareholders of an S-Corp are only liable to the amount of their investment in the company. The personal assets of the shareholders will remain protected.
Pro #4: A California S-Corporation Provides You With Longevity and a Continual Existence
A California S-Corp essentially consists of the shares and shareholders. This means that the business has an unlimited life and will continue to exist regardless of what happens to the owner, director or founder because there will always be shareholders.
Pro #5: A California S-Corporation Provides You With More Corporate Structure
A California corporation has more formalities when it comes to management. A corporation consists of three main groups of people: officers, directors, and shareholders.
Each group has its own set of clearly-defined roles and responsibilities within the corporate framework which you may find to be beneficial in your particular situation.
Often times our entrepreneurs like having this organized structure where duties are delegated to different individuals.
Cons of a California S-Corporation
Corporations certainly have their benefits but they also have plenty of downsides.
Con #1: A California Corporation Makes it Harder to Raise Capital from Non-US Residents
Although having an S-Corporation will be more attractive to investors and provide you with more opportunities to raise capital, it also limits your ability to raise money from investors.
If you plan on raising capital, it is important to keep in mind that only US residents can own shares of an S-Corporation so your pool of investors in drastically limited. You will only be able to raise money from US residents.
Additionally, an S-Corp can have only 100 shareholders and can only have one class of stock which limits the level of control the shareholders can have over the company.
If you intend to have more than 100 shareholders or want to be able to sell shares to non-US residents, then it will likely be better for you to form a C-Corporation.
Con #2: A California Corporation Has More Costs and Requires More Maintenance
An S-corp requires you to file more documents with the state of California than an LLC. These documents include the articles of incorporation, statement of information, IRS form 2553, and more. (See Our S-Corp Checklist Here)
The yearly fees are also higher for an S-Corp than with an LLC. If you want to maintain status as a corporation and keep the liability protections then it is required to pay these annual fees.
There are also yearly compliance rules that are more complicated than those required of an LLC. This includes holding shareholder and director meetings whereby you are required to keep a record of your meeting minutes.
Con #3: A California Corporation Requires You to Have More Meetings
Unlike LLCs, S-Corps have to hold regular meetings and maintain company minutes.
This means that the shareholders, directors, and officers will have to come together frequently and discuss various operations of the business.
While this may be a good thing, it is certainly an inconvenience for many of our entrepreneurs.
Con #4: A California Corporation Requires The Shareholders to Be US Residents
In order to file for an S-Corp, you must be a U.S resident.
As mentioned above, this means that all the investors in the S-Corp must also be U.S residents if they are purchasing shares of the corporation from you.
Which One Should I Choose?
First of all, both structures are very good choices for your California business. However, it is still important to determine which is the best option for you.
Both structures are very effective in providing the owner with limited liability.
It boils down to taxes, fees, maintenance, corporate formalities, and whether you want to raise money.
California LLCs are more popular for new entrepreneurs that want to keep things simple and cost-effective and do not want to raise money or have the ability to sell shares.
California S-Corporations are better for the entrepreneurs that anticipate making large amounts of money in the first couple of years and also foresee needing to raise money from US residents.
Don’t worry, you can always change the entity later if things change.
What To Do Next?
As a Business Lawyer for Entrepreneurs, I’ve assisted hundreds of clients just like you start their California U.S. business and I can definitely help you start yours.
We offer a comprehensive California Package that includes everything you need to start your California business that includes:
- Registered Agent Service
- Getting you your EIN
- Filing your articles of incorporation
- Drafting personalized bylaws for your corporation
- Checking to make sure the name is available
- Filing form 2553 to get S-Corporation tax status (if beneficial for you)
- Filing your statement of information
- Providing you with your corporate minutes,
- Tax Assessment With Expert Accountant to Help you Save Money on Taxes.
- Comprehensive Business Welcome pack.
- 5 essential business templates for new entrepreneurs.
- All state filing fees included.
- Offering Post-Incorporation Advice and Support for 1 year
- Offering you peace of mind with a business lawyer on your side to make sure that you are set up correctly and in compliance with federal and state requirements.
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