Today I am going to explain to you the difference between a California Corporation and a California LLC and help you make a decision as to which one is better for you.
Often times choosing the right business entity can make or break your business, so it is important to do some research before deciding.
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 a California Corporation or neither of them.
The Importance of Choosing The Right Business Entity
So you are starting your business and keep hearing that you should put it into an LLC or a Corporation.
There is no doubt that having a business entity is very important. As I am sure you know, a business entities main purpose is to provide you with liability protection and provide you with various tax benefits.
There are several factors that must be considered when choosing the right California entity including how much money you will be making, whether you live in the US, and what your future plans are for the company.
Deciding between an LLC and a Corporation can have major consequences such as having to pay more in taxes, being unable to attract the right investors, and having to pay more annual fees each year.
Overall, choosing the right structure is very important and can make or break your business. The main thing that you should focus on is personal liability protection, taxes, and your future plans for the business.
I strongly recommend reaching out to an experienced lawyer such as myself by emailing me at firstname.lastname@example.org, so I can evaluate your specific case and then decide which entity is best for you.
Who Can Form a California LLC or Corporation?
Many of our clients are very surprised to find out that they can form a California LLC or California Corporation even if they do not live in California or even the US.
This means that forming a California LLC or California Corporation is not limited to only California residents.
It is not uncommon for international entrepreneurs or out of staters to file for an LLC or Corporation in California.
Similarities and Differences Between LLCs and Corporations
Both LLCs and corporations have many similarities and differences.
Both California LLCs and California Corporations Provide You With Liability Protection
The biggest similarity is that both entities provide the owners with liability protection by requiring you to get a tax identification number (EIN) and open a bank account under the business name. This means that regardless of whether you choose to form a California LLC or a California Corporation, your personal assets will be protected from creditors and judgments.
California LLCs and Corporations Have Very Different Formation Requirements
A California Corporation and an LLC have very different structures and formation requirements.
A California corporation is formed by filing articles of incorporation with the state of California, creating bylaws, and selecting a board of directors to oversee the daily operations. A corporation has a set number of shares and is thus owned by the owners of those shares. Overall, a corporation has more structure and requires you to follow more formalities than with an LLC. See our article on how to form a California Corporation.
A California LLC is formed by filing articles of organization with the state of California. The members (owners) of the LLC then must create an operating agreement which will dictate how the LLC is managed from day to day and state each members percentage of ownership. See our article on how to form a California LLC.
California LLCs and Corporations Are Owned Differently
One of the main differences between a California LLC and a California Corporation is the way in which they are owned by the members or stockholders.
With a corporation, the business is owned by the stockholders. Stockholders are the individuals that purchase shares of the corporation. This means that with a California corporation the business can decide to sell shares to raise money from outside investors more easily.
With an LLC, the owners of the business do not have shares but rather have an equity interest in the business. This equity interest is oftentimes determined based on the amount of money that the individual contributed to the LLC when formed.
While both LLCs and Corporations are similar in that they can be owned by multiple people, the form of ownership is very different.
California LLCs and Corporations Classify Profits and Losses Differently
It may be surprising to you to think that profits and losses can be construed differently depending on whether you have an LLC or a corporation.
With an LLC, the profits and losses are passed through to the individual owners whereas with corporations the profits and losses are held by the corporation. This means that with an LLC, the business income and losses are considered to be the members (owners) and the taxes will be paid on your personal tax return.
However, with a California corporation, the profits and losses are held by the corporation and are not passed through directly to the owners. Instead, profits are distributed to the owners when the corporation decides to distribute dividends.
This means that a corporation will be taxed once at the corporate level and then the shareholders will have to pay personal tax again when dividends are distributed.
It is very important to take profits and loss calculations into consideration before choosing a California LLC or California Corporation.
California LLCs and Corporations are Taxed Differently
Taxes are one of the most important factors to consider when deciding whether you want a California LLC or a California Corporation.
An LLC has pass through taxation meaning that the profits made by the LLC will be passed directly through to the member’s personal income. However, with a California corporation, you will have to pay tax at the corporate rate and then again as a shareholder when dividends are distributed.
However, it is important to note that with an LLC you will also have to pay self employment taxes (social security and medicare) on your share of the LLC profits each year. Corporate shareholders however do not have to pay this tax.
Overall it is very important to reach out to an experienced lawyer like myself at email@example.com or contact your accountant before deciding which business entity is right for you from a tax standpoint.
What to Consider Before Deciding Which One is Better?
You should not have a better understanding of the most common similarities and differences between a California LLC and a California corporation.
Now I will now explain what you should consider before deciding which one is better for you.
What is Your Business Purpose?
The purpose of your business plays a huge role in what business entity you should form.
If you intend to form a business so that you can have the liability protection and you do not foresee your business needing to raise money from outside investors, then it is likely that a California LLC would be more beneficial for you.
However, if you have high aspirations for your business, plan on raising money, and want a more formal business management structure, then a corporation may be the best option for you.
Cost, Time, and Structure
Forming a California LLC is less expensive and requires you to put forth significantly less time dealing with complicated forms and following corporate formalities.
With a California Corporation, you will have to spend more money creating the corporation and will have to exhaust more of your time dealing with mandatory reporting requirements and following corporate formalities.
Both LLCs and Corporations are required to fulfil reporting requirements and pay annual fees to the state of California. However, California Corporations have more requirements than an LLC.
Corporations are required to hold annual shareholder meetings each year where you will have to document discussions and keep a record of decisions that are made.
An LLC will not require to to keep minutes hold annual meetings or have a board of directors.
Overall, if you are the type of company that does not want to deal with complicated paperwork and satisfy numerous state requirements, then a California LLC will be for you.
Will Professionals Be Involved?
In California, licensed professionals, such as doctors, lawyers, accountants, and engineers cannot form LLCs. Instead, a professional will have to form a professional corporation.
This means that if you want liability protection for your business that has professionals involved, then a corporation may be the only option for you. See our article on professional corporations.
Attracting Passive Investors?
When deciding which entity to choose, it is important to consider what your investors will prefer.
Generally speaking, a corporation is more attractive to passive investors. This is primarily because corporations split ownership and management of the company.
Not only will investors prefer to invest in a corporation, but their governing documents may not permit them to invest in LLCs. Generally, it is also easier for a corporation to obtain bank financing.
Overall, if you foresee yourself needing to raise money, then you should seriously consider incorporating in California rather than forming an LLC.
What To Do Next
Overall, a California corporation is the best choice for your business if:
- You intend to raise money from outside investors or venture capital firms
- You want your company earnings to stay in the business to help it grow
- You prefer to have more structure and 2 different classes of shares
- You want the option to easily sell your business down the road.
- You don’t mind spending time complying with the corporate formalities
- You don’t mind spending the extra money on reporting requirements and fees.
- You are a professional and your only option is to have a professional corporation
- The tax benefits of an LLC are outweighed by the benefits of a corporation.
When you are considering which structure to choose it is important to not only think about where your business will be this year, but also where it will be in 5-10 years.
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.
The first step is to book your free call here or email me at firstname.lastname@example.org to have a free consultation. discuss the options for you. I will help analyze your situation and determine which entity is right for you. Please also keep in mind, it is possible that neither a California LLC or Corporation will be the best entity for you.
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