There is quite a big challenge when considering what California business structure to operate through in this state. And the main decision of the business owners is whether to choose a California LLC or S Corp.
Both of the corporations are excellentand provide liability protection, but they have a couple of important differences that we will briefly describe. A business owner must also consider a few other personal objectives when selecting their choice:
- administrative requirements
- LLC fees, state franchise taxes
- employment tax implications
- eligibility of owners
- operational ease
The business owners must consult with an experiencedagencyto discuss the difference between LLC vs. S Corp sot they can get legal advice.
What is LLC (Limited Liability Company)
The California LLC (Limited liability company) are popular because of their basic benefits of liability protection and are mainly used by a sole proprietor (single owner) or a company with multiple owners (partnership). LLCs defend the owner’s individual assets from losses, business debts, or court rulings against the company. This may also include some tax benefits since they are taxed separately from traditional corporations.
A Limited Liability Company can also be utilized as self-employment (single member or one owner) for a company of almost any size, such as a legal entity, doctor’s office, etc. These pay a self-employment tax.
All gains and losses pass within the company to the LLC owners (aka ‘members’). And if the LLC is taxed as a partnership, the members themselves state the profits/losses on their general income tax. What separates the LLC from the partnerships is the level of liability for which a member is responsible.
General partnership membersor sole owners hold liability for all the business debts – they do not shield themselves of tort actions, such as accidents. This is the main reason why it is necessary to discuss this with an experienced attorney. To register an LLC you need to send detailed information to the secretary of state.
What is an S-corp?
An S corporation or also known as S-corp or S subchapter isn’t a type of business, but rather it is a tax classification. Unlike the traditional C-corporation, an S-corp doesn’t handle corporate income tax. And they are corporations that sustained an IRS designation. To even become an S-corp, your business must first file a registration request as a C corporation or LLC.
An S corporation’s model also guards business owners’ personal assets against any corporate liability and passes over income, regularly in the form of dividends, to avoid double corporate and personal tax returns.
The IRS explains that the S Corps model is a unique business entity that is separated from the business owners. As so, the business owners possess limited liability. To process the corporation’s legal protection, it is essential not to blend corporate and personal finances. In an S-corp, the business owners are named shareholders.
So to qualify as an S-corp, there are a couple of strict rules that you must follow:
- Your business must file a request to the IRS as an American corporation
- You won’t be able to file a request if the business is owned by people who aren’t U.S citizens
- Your company must have 1 to 100 shareholders.
- Any other corporate entity cannot hold the S corporation
- It can only consist of a single class of stock
What is the difference between LLC and S-corp in California?
Most small business owners mainly choose to operate as a Limited Liability Company (LLC ) because it provides more freedom than the S-corp structure. But before jumping to a conclusion, it is quite crucial to understand all the differences between limited liability companies and S-corporations. Let’s go ahead and spot the most important difference between these two structures and see the best business structure for California.
Both an S-corporation and LLC defend their owners from personal liability for the business’s operations, such as lawsuits and debts. However, neither legal entity is designed to shield a person from criminal obligations.
The S-corporation can be bankrupt, and the shareholders can find that their company’s stock possessions are worth nothing. Legal actions usually can’t move any further to claim the individual assets.
The LLCs are the root of partnerships, but one has been granted equal liability protection as an S-corporation.
An LLC structure is a matter of state law, while an S-corp is a matter of federal tax law. The S-corp isn’t considered to be a business entity like the limited liability structure. ( Sole proprietorship & partnership) It is pretty important to choose what kind of way your corporation will be taxed. By choosing an S-corporation tax status, your business will be able to stay away from double taxation. Double taxation occurs when the business is taxed on their profits and then taxed again on the dividends that shareholders acquire as their gaining.
In an LLC structure, the members are required to handle self-employment tax. (Social Security and Medicare taxes) These tax rates vary on an annual basis, so this isn’t a steady number.
California LLC tax rates range from $800 for LLC tax, an LLC fee that varies from $0 up to $11,790, and FICA tax that stands at 15.3% of taxable wages.
By operating an S-corp, the shareholder is paid a salary. The business pays for all their payroll taxes, which are deducted as a company expense from the company’s taxable income. In California, an S corporation’s net income is taxed at 1.5 %. And it is also taxed a second time when it is passed through to the shareholders.
Another thing that separates the LLCs and s-corps is different management operations.
An S-corporation has an established management structure, with a board of managers handling management conclusions and officers controlling everyday tasks. The shareholders elect directors and vote in important corporate choices.
When many people manage an LLC, the LLC is much like a partnership or a sole proprietorship if there’s only one member. LLC is quite more flexible when it comes to management. No meetings or hours are required, no managers beyond one managing member are needed, and members can be appointed as managers very simply through the entity’s operating arrangement. If run by managers, the limited liability corps more closely resembles a corporation, as members will not be involved in the daily business decisions.
On the other hand, assigning ownership in an s-corporation is as easy as transferring stock purchasing – purchasing, gifting, trading, and inheriting are standard legal actions. With an LLC, assigning ownership values or preferences between current, excluding, or inviting new members demands a change in the operating agreement supported by the voting membership.
A corporation exists permanently. It has no closing date as an entity and from its development is regarded as existing in perpetuity unless terminated. Limited liability corp is more dependent on its state law. It can be selected as a perpetual entity during its formation.
An infinite number of characters or legal entities can own pieces in a corporation. Likewise, an LLC can have endless membership of persons or entities such as other LLCs or corporations, etc.
S-corps aren’t allowed to consist of more than 100 shareholders in total, while an LLC can have an unlimited number of members in their corporation. Also, the S-corporation can’t have non-U.S. citizens, while the LLC allows non-U.S. citizens to be a part of their corperation.
They also possess different subsidiary limitations. LLCs have authorized subsidiaries without restriction, while S-corps aren’t authorized to set up any subsidiaries.
Picking the correct entity demands comprehensive research on how the guidelines and restrictions will affect your business taxes, management operation, and ability to form subsidiaries and issue stock formation.
Which is better, an LLC or S Corp?
It depends on your company’s need. If you file to form an LLC, that would be a good approach to begin with because this business gives liability protection and income tax returns. But, as your corporations grow beyond the startup stage, switching to an S-corp may make better financial sense.
As income from the LLC significantly increases, so does the self-employment tax. And with an S corporation, the owners can take a wage from the profits and apply the Foreign Earned Income Exclusion to reduce income tax.
S-corps may make more sense when it comes to finances operating for many corporations. Still, unless there is a particular reason to perform the switch, it may not be the most beneficial move for a single-member LLC. There are some downsides of having to handle self-employment taxes, but in an S-corp, the business owner is obliged to take salaries under the IRS’s reasonable compensation regulations.
Whether your company organization should be an LLC or an S-corporation depends on where your business is located. LLCs mainly work the best for newbies and beginners, but as your corporation grows, you may want to convert into an S-corp to decrease self-employment taxes.
Frequently Asked Questions
Should I file my LLC as an S Corp?
While the ideal corporation for your business really depends on the owners and the business itself, you should be aware of both the advantages and cons if you have your LLC taxed as an S-corporation.
- The company pays your wages and the payroll taxes on it. This may spare you money on taxes because you would handle self-employment taxes on the business’s gross receipts income as with a regular LLC.
- Additional profits are spread to shareholders as dividends. This may also help you save money since dividends taxes are at cheaper rates.
- There is a salary cap. You must set reasonable considerations for owner-employees.
- You’re restricted to one class of stock and 100 shareholders.
- Shareholders control more than 2% of the company’s stock and can’t maintain employee health insurance as a tax-free privilege as they could with a C-corp.
By running a public questionnaire, most businesses have selected that having your LLC tax as an S-corporation once you hit at least $65,000 a year mark is a pretty great decision for their business. Having your LLC taxed as an S corporation can save you a lot of cash on the employment tax if you are a single owner. But, you must file an individual S-corp tax return, which means paying your CPA to file an additional form. An S-corp is likewise less structurally flexible than an LLC.
Do you have to pay the $800 California S Corp fee the first year?
Starting from January 1, 2021, until December 31, 2023, any LLC, LP, or even LLP that files, registers, or coordinates to do business within the California state are required to pay a minimum annual franchise tax of $800 for its first taxable year.
So, in the end, whether your business should be advancing as an LLC or an S-corp in California should be calculated with a lot of patience and knowledge. It should be clear that the differentiation between an S-corporation and an LLC offers a great mix of possible advantages and disadvantages to every particular business. No one can declare what is the true winner here. The tax implications to the company and its partners and its plans and goals should all be considered when making the final decision.
Choosing LLCs will be a lot more affordable and easy to set up. It will also be simpler to manage and to keep in agreement with the law. And on the other hand, S Corps is a more logical choice in some cases and may require many more skills and previous experience. Obtaining an S Corp is perfect if your business intends to go public sometime or may attempt substantial external financing. Although transferring your business structure is possible, such changes may acquire additional tax liabilities to the business structure.
No matter which business entity you choose, ZenBusiness can help you with your essential business filings in California. Their team of experts will file all your business paperwork quickly and accurately, guaranteed.