As a new business owner in the state of California, one of the biggest decisions you will make is whether you want to form an S Corporation or a Limited Liability Company.
Both LLC and S Corp will provide you with personal asset protection, tax advantages, and several other benefits. But each business entity does have a lot of key differences as well.
While I highly recommend contacting an experienced business attorney such as myself at firstname.lastname@example.org to help you when you decide to establish a new business, I’m hoping this article highlights some key information to make the selection process a little easier on you.
What to Consider When Selecting Your Business Entity
Trying to sort out how an LLC differs from an S Corp is confusing and overwhelming. Fortunately, there is a solution to that problem.
You just need to focus on these key areas:
- Personal liability protection
Before you can address these things, it is important to take a step back and look at the bigger picture.
How many owners (or members) a business has and what role they have plays a huge part of which entity is the better choice.
I highly recommend reaching out to a seasoned attorney such as myself at email@example.com, so I can look at the purpose of the business before deciding which business entity makes more sense for you.
S Corporation Definition
An S Corp is a business entity that limits your personal liability associated with your company. A S Corp differs from a corporation because it elects to pass corporate income, losses, deductions, and credits to the shareholders for taxation purposes.
How Does Forming an S Corp Protect Your Business?
The key benefit to establishing your business as an S Corp is – as a shareholder – is not having to file self-employment taxes. Instead, you just get taxed on the salary you pay yourself instead.
Just like a corporation, an LLC will also offer your business liability protection by requiring you to get a tax identification number and open a bank account under the business name.
How Does Forming an LLC Protect Your Business?
The number one reason to form an LLC is to avoid personal liability issues for debt and lawsuits connected to a business a person is involved with or owns.
When you form an LLC, the LLC itself becomes liable for all its debts and lawsuits instead of the owners and managers.
S Corp vs LLC For Your California Business
You now understand the definition of LLC vs S Corp. You also understand how they protect your business.
The question becomes – how do you choose which one is right for your business?
In order to choose the right business entity, you need to start by writing down the answers to these five questions:
- How does your business generate profit?
- Who will be the owner of the company?
- Who will manage/operate the company?
- What are the gross and projected net revenues?
- How will you split profits between multiple owners?
Once you write down the answers to these six questions, I suggest contacting a lawyer such as myself at firstname.lastname@example.org to go over your answers.
Answering the questions is hard enough and selecting a business entity is a complex process. You need an experienced attorney to help you.
7 Variables of Choosing LLC vs S Corp
Once we have the answers to the five questions above, you and I will look at a few different variables to decide what works best for your business needs.
1. Business Purpose
The purpose of your new business venture plays a huge role in what structure works best for your needs.
A holding company, for example, should be set up as an LLC. Business ventures dealing with services or products often function better as a corporation.
In my personal experience, the last thing an entrepreneur in California wants is a mountain of paperwork. Limited liability is the way to go if paperwork is an issue.
There are a lot of formalities and forms the government requires of an S Corp that it does not require of an LLC.
There is a loophole for someone who doesn’t like paperwork, but wants to form an S Corp. You hire an experienced business attorney to handle the paperwork for you.
Technically, part of being a good business owner is knowing how to pass off some of the work to lighten your load.
You can contact a corporate attorney such as myself at email@example.com, get the business entity you want, and not have to deal with the paperwork.
To form an S Corp, your owners must live inside of the United States as legal citizens.
You also need to ask yourself whether the business is being managed by an owner or a company.
If managed by an owner, you need to form an S Corporation. If managed by a company, you must form an LLC.
Some business owners are drawn to LLC structure because it offers protection to co-owners. Technically, you can get this same protection as an S Corp.
So, it’s important not to give too much importance to this one benefit of an LLC.
If you are forming a business with professionals, you can’t form an LLC. They can only form a professional limited liability company.
So, if professionals are involved in your business it limits you to an S Corp by default.
6. Gain and Loss Allocation
In an S Corporation, you have the flexibility of different allocations. Meaning you can put in one percentage of money and take out another.
Under an LLC, your gain and loss allocation must be the same. So, if you put 10 percent in, you take a 10 percent loss as well.
While both S Corp and LLC will have to pay the minimum franchise tax fee, other aspects of taxation are a little different.
LLCs are required to pay income and self-employment taxes. S Corp shareholders pay income and payroll taxes.
The key difference being that self-employment tax. Companies expecting to distribute a lot of funds are better off forming as an S Corp for tax purposes.
If you take the answers to the five basic questions above and use them to look through these seven variables, it becomes much easier to decide on a business entity.
As you can see, there are certain aspects of your business that may force your hand one way or the other.
What To Do Next
At Mollaei Law, I have advised many aspiring entrepreneurs on ideal business structures and steps for incorporating or forming an LLC. Speaking to an experienced business attorney such as myself at firstname.lastname@example.org is a crucial step in the process.
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