LLC vs S-Corp | What Entrepreneurs Need to Know in California

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LLC vs S-Corp in California

When starting a small business in the California, one of the most important decisions you’ll make is choosing the right legal structure. Two popular options for small businesses are electing for S Corporation (S-Corp) or forming an LLC in California. Both offer certain advantages and drawbacks, making it crucial to understand their differences and determine the best fit for your business. 

If you want to know more about LLC vs. S-Corporation, which is better and suitable for the business you will form, you should consider a few things. Before we get through this article, you should understand LLC vs. S-Corporation in California. 

Webinarcare Editorial Team will help you define and understand the difference, and you must be guided by all the factors gathered in this article.

LLC Vs. S-Corporation in California

LLC vs. S-Corporation: Definition

A limited liability company is a type of business structure that guards against the impact of business liabilities on your personal assets. However, while not a typical business structure, the S Corp is a tax status you can register with the IRS. Unlike an LLC, an S-Corp does not offer personal asset protection. The two are explained in detail here:

What is an LLC in California?

A legal corporate organization that protects personal assets is a limited liability company (LLC). With this setup, the LLC member or owner can protect their personal assets if their company faces financial difficulties or becomes the subject of legal action. In some unique circumstances, the opposing party may pursue your personal assets if your firm is sued in court. When you are held personally accountable for the company’s debt, this is called “piercing the corporate veil.”

By creating an LLC in your state, you can take advantage of the pass-through tax benefit, which means that your personal income will be used to determine your income tax obligations rather than the revenue generated by your firm. 

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What is an S-Corp in California?

Unlike a limited liability company (LLC) or other business structures, California S-Corporation is not a type of corporate entity. It’s a tax classification that, though in various ways for corporations and LLCs, might lead to considerable financial savings. S-Corporations are similar to LLCs, except that the Internal Revenue Service recognizes them as corporations for taxation purposes. 

A well-known alternative to the LLC is the S-corp. In contrast to a traditional C-corp, an S-corp is better suited for small and medium-sized firms, such as those with 100 total stockholders. 

LLC Vs. S-Corporation in California

Creating a business in California requires careful consideration, especially when deciding whether a state LLC or an S-Corporation is more advantageous. An LLC is a legal corporate structure, but an S-Corporation is a tax categorization which some small firms are eligible for. Forming California Corporations and LLCs can elect S-Corporation taxation by filing paperwork with the Internal Revenue Service (IRS). Making an S-Corporation may be less formal than establishing an LLC, and it typically offers less security. Additionally, S-Corporation in California does not offer the same safeguards that business owners seek in an LLC. When starting a business, thinking about your alternatives from a legal and tax perspective is important.

It is suggested that you speak with a legal professional before you begin setting up an LLC. They’ll understand what’s best for you and your company. To safeguard your personal assets from business debts, you can always start an LLC in California.

– WEBINARCARE EDITORIAL TEAM

Tax Difference Between LLC and S-Corp in California

There is a distinction between an LLC and an S-Corporation regarding taxation. Based on the differences in Federal and State taxes, you can determine whether S-Corporation or LLC in California is best for your business.

Federal Taxes 

There are a few federal tax factors to consider when selecting whether to operate an LLC or S-Corporation in California. Tax differs in terms of Pass-Through Taxes and Self-Employment Taxes.

  • Pass-Through Taxes: LLC and S-Corporation in California are the same regarding pass-through taxation at the federal level. LLCs and S-Corporations do not pay federal income taxes as separate legal entities because of pass-through taxation. Only their owners must pay federal income taxes on their portions of the business income. The company does not pay twice the tax in this kind of taxation. Unlike LLCs and S-Corporations, C-Corporations in California are mandated to have double taxation. It means that they must pay federal taxes at the entity level.
  • Self-Employment Taxes: Most LLC owners choose S-corporation taxation in California to reduce their self-employment taxes. This is because if you own an S-corporation, you are not required to be self-employed. Instead, you can join the company as an employee and receive regular salary benefits. On the other hand, an LLC member must include their guaranteed payments and a portion of the LLC’s earnings in calculating their self-employment tax. Distribution of shares defines S-Corporation shareholders in terms of their corporate incomes. 

Consider the following scenario: you are the sole owner of an LLC in California with a $200,000 annual profit. And $150,000 is a fair wage in your area for someone doing the same job as you. Under the default LLC taxation, you must pay self-employment taxes on the entire $200,000 profit. However, if your business is taxed as a state S-corp, you must only pay payroll taxes on the standard wage of $150,000. The remaining $50,000 will still be subject to income tax.

California State Taxes

At the state level, there aren’t any significant tax differences between regular LLCs and S Corporation LLCs. In terms of the annual LLC fee in California, it costs $10, $20 every 2 years, which can be paid to the California Franchise Tax Board. Of course, before forming the whole LLC, you must pay the initial fee of $70 to the California Secretary of State.

LLC Vs. S-Corp Ownership Comparison

LLCs and S-Corporations in California have different ownership requirements that can impact your choice of business structure. Here’s a comparison of the key ownership requirements for each structure:

1. Number of Owners

California LLC: An LLC can have any number of owners, called members, from starting California Single Member LLC to multiple members LLC. There is no upper limit on the number of members an LLC can have.

California S-Corporation: An S-Corporation is limited to a maximum of 100 shareholders (owners). This restriction can be a limiting factor for businesses that plan to have many owners or seek outside investment.

2. Type of Owners

California LLC: An LLC can have various owner types, including individuals, corporations, other LLCs, trusts, and estates. Non-resident aliens can also be members of an LLC, like forming a Foreign LLC in California.

California S-Corporation: S-Corporations have more restrictive ownership requirements. Only U.S. citizens and resident aliens can be shareholders of an S-Corporation. Additionally, other corporations, LLCs, and certain types of trusts and estates are not eligible to be S-Corporation shareholders.

3. Classes of Ownership

California LLC: An LLC offers flexibility regarding ownership classes. Members can have varying levels of management rights, profit distribution rights, and voting rights, creating different classes of membership interests.

California S-Corporation: S-Corporations are limited to only one class of stock. While shareholders’ voting rights may differ, all shareholders must have equal rights to profit distribution and liquidation proceeds.

4. Profit Distribution

California LLC: Profit distribution in an LLC is flexible, allowing members to allocate profits and losses in any proportion they choose. This can be outlined in the California Operating Agreement.

California S-Corporation: Profits and losses in an S-Corporation must be distributed to shareholders based on the percentage of shares each owns. This can be less flexible than the profit distribution options available to an LLC.

California LLC offers more flexibility in ownership requirements, allowing for a greater variety of owner types, multiple classes of membership interests, and flexible profit distribution. In contrast, an S-Corporation has more restrictive ownership requirements, limiting the number and type of shareholders, allowing only one class of stock, and requiring proportional profit distribution based on share ownership. Consider these differences when deciding which business structure best fits your needs and goals.

Which is easier to incorporate in California: LLC or S-Corp?

Filing an LLC or S-Corporation in California requires planning and time. Even though it is not as simple as it appears, something manageable keeps it from being too difficult. LLC and S-Corporations can be formed using Agent for Service of Process. To establish an LLC in California, you must submit the Articles of Organization to the California Department of Tax and Fee Administration. Your Articles of Organization must include information about your California LLC, as well as payment of the associated filing fee.

Furthermore, you must submit additional papers to make the California S-Corporation election. Fill out Form 8832 to notify the Internal Revenue Service that you prefer to tax your LLC as a corporation rather than a partnership. Then you’ll submit Form 2553 to select S-Corporation status.

Remember that you must file annual tax returns and reports after forming your LLC to remain legally compliant.

Who Pays More Taxes in California: LLC or S-Corp?

Taxes for LLCs and S-Corporations in California depend on the tax purposes and the profit generated. LLCs are typically taxed at personal rates, and LLC owners can be treated as separate companies with their own federal tax identification numbers. You can check the California LLC Cost for detailed information.

California S-Corporation owners, on the other hand, must be paid a salary that includes Social Security and Medicare taxes. On the other hand, the owner can receive dividend income or some of the leftover profits without being classified as an employee and thus will not be subject to Social Security and Medicare taxes on that money.

Should I Incorporate California LLC as an S-Corporation?

Forming an LLC may be advantageous because your business assets are separate from your personal assets if you are a sole proprietor. You are not restricted from converting your LLC to an S-Corporation. Although an S-corporation must have a board of directors, a maximum of 100 shareholders, and follow more regulations, it is ideal for larger companies with more shareholders.

How do you convert LLC to S-Corporation in California?

You must submit Form 2553, Election by a Small Business Corporation, to the IRS to elect S-corp taxes if you want to form an LLC as an S-Corporation in California. A Form 2553 must be submitted by 75 days following the creation of your S-Corp or by 75 days following the start of the tax year in which the election is to be effective. 

You must also submit Form 8832, Entity Classification Election if your LLS-Corp has passed the deadline of 75 days and you wish to elect to be taxed as a corporation. You would collectively transmit Forms 2553 and 8832 via certified mail from the USPS. You can send your Form 2553 to the Department of the Treasury Internal Revenue Service Center – Ogden, UT 84201 Fax: 855-214-7520​ in California.

FAQs

What is the main difference between an LLC and an S-Corp in California?
One major difference is the way taxes are handled.
Which entity type is better for small business owners in California?
It depends on your specific circumstances and priorities.
Is forming an LLC or an S-Corp more expensive in California?
Generally speaking, forming an S-Corp is slightly more expensive.
Does California have any special requirements for LLC formation?
Yes, California has specific rules and fees for LLC formation.
Are LLCs required to hold annual meetings in California?
No, California law does not require LLCs to hold annual meetings.
How do LLCs and S-Corps differ when it comes to income taxes in California?
S-Corps are taxed differently than LLCs—specifically, S-Corps file an information tax return instead of a standard corporate tax return.
Can an LLC elect to be taxed as an S-Corp in California?
Yes, LLCs can choose to file taxes as an S-Corp if they meet certain criteria.
What are the eligibility requirements for an S-Corp election in California?
There are specific criteria that must be met in order for a corporation to qualify for S-Corp status in California.
Are there limitations on the number of shareholders a California S-Corp may have?
Yes, California has specific limitations on the number of shareholders an S-Corp may have.
Are LLC owners considered employees for tax purposes in California?
No, LLC owners are not generally considered employees for tax purposes in California.
What documentation is required to form an LLC in California?
There are several documents and forms that must be filed in order to properly form an LLC in California.
Does California require a consensus for LLC decisions?
Yes, California law generally requires LLC decisions to be made by unanimous vote.
Can an out-of-state business file as an LLC in California?
Yes, out-of-state businesses can file as LLCs in California.
Do LLCs in California have limited liability protection?
Yes, LLCs offer limited liability protection to their owners.
Do California LLCs have any restrictions on member liability?
In general, members of California LLCs are not personally liable for the company’s debts.
Are LLCs and S-Corps taxed at the same rate in California?
No, LLCs and S-Corps are taxed differently in California.
Are there any tax penalties for late filing or misfiling of S-Corp taxes in California?
Yes, there may be penalties for late or incorrect filing of S-Corp taxes in California.
Can an LLC be both member-managed and manager-managed in California?
Yes, it is possible to have a California LLC that is both member-managed and manager-managed.
Are S-Corps subject to California’s franchise tax?
Yes, S-Corps are subject to California’s franchise tax like any other corporation.
Can LLCs have multiple classes of stock in California?
Generally speaking, California LLCs are not allowed to have classes of stock.
What types of fees are associated with LLC formation in California?
California charges filing fees for LLC formation, among other costs.
Are there any annual reporting requirements for California LLCs?
Yes, California LLCs must file an annual report with the secretary of state.
Can a disqualified person own shares of an S-Corp in California?
No, California law prohibits disqualified persons from owning shares in an S-Corp.
What are conditions to properly maintain S-Corp status in California?
Taking care to maintain eligibility requirements, the right nature of income receipts and timely filing of paperwork are critical conditions to maintain S-Corp status in California.
Are there any tax implications for winding down an LLC or S-Corp in California?
Yes, there can be both cost savings as well as tax penalties when winding down an LLC or S-Corp in California.
Can a California S-Corp convert to an LLC or vice versa?
Yes, it is possible for a California S-Corp to convert to an LLC or for an LLC to convert to an S-Corp.
What role does residency play in forming an LLC or S-Corp in California?
California domiciles allow business owners to incorporate as either an LLC or an S-Corp, regardless of their residency.
Are an LLC’s profits subject to self-employment tax in California?
It depends on how the LLC taxed itself and inclusion of owners’ salary coverage.
Are foreign individuals allowed to own shares in a California corporation?
Yes, foreign individuals are allowed to own shares in California LLCs and S-Corps.
What is the difference between an LLC and an S-Corp in California?
An LLC is a legal entity that protects its owners from personal liability and is taxed similarly to a sole proprietorship or partnership, while an S-Corp is a corporation that allows its owners to avoid corporate taxes and is taxed like a partnership.
How do I form an LLC or an S-Corp in California?
You can form your LLC or S-Corp in California by filing the necessary paperwork with the California Secretary of State and paying the appropriate fees.
What are the filing fees for an LLC or an S-Corp in California?
As of 2021, an LLC filing fee in California is $70, while the filing fee for an S-Corp is $100.
How long does it take to form an LLC or an S-Corp in California?
The processing time for LLC and S-Corp formation varies but generally takes around 2-3 weeks in California.
Can an LLC or an S-Corp have a single owner in California?
Yes, both LLCs and S-Corps can have a single owner in California.
Are there any residency requirements for owners of an LLC or an S-Corp in California?
There are no residency requirements for owners of an LLC or an S-Corp in California.
Does a California LLC or S-Corp need a registered agent?
Yes, both LLCs and S-Corps in California are required to have a registered agent with a physical address in California.
Can an LLC or an S-Corp be entirely owned by non-US citizens in California?
Yes, both LLCs and S-Corps can be owned by non-US citizens in California.
Are there any annual fees or taxes for LLCs or S-Corps in California?
In California, LLCs and S-Corps are required to pay an annual franchise tax fee, and certain LLCs may be subject to additional annual taxes based on revenue.
Can LLCs and S-Corps in California change their tax status in the future?
Yes, both LLCs and S-Corps in California can change their tax status at any time, but the process may require additional paperwork and fees.
Can a California LLC or S-Corp be converted to a different business structure?
Yes, both LLCs and S-Corps in California can be converted to a different business structure, but the process may differ depending on the new structure.
Do LLCs and S-Corps have the same liability protections for their owners in California?
Yes, both LLCs and S-Corps in California provide limited liability or legal protection for their owners from business lawsuits and debts.
Can an LLC or an S-Corp operating in California be taxed as a C-Corp instead?
Yes, both LLCs and S-Corps in California can choose to be taxed as a C-Corp if they meet certain legal requirements.
Are LLCs or S-Corps better for businesses looking to attract investors in California?
S-Corps are generally better for businesses looking to attract investors in California due to their ability to issue stock and avoid double taxation.
Can LLCs or S-Corps in California operate more than one business simultaneously?
Yes, both LLCs and S-Corps in California can operate more than one business simultaneously, but all business activities must fall under the same overall business purpose.
Is it easy to dissolve an LLC or S-Corp in California?
Dissolving an LLC or S-Corp in California requires filing specific paperwork and notifying all creditors and authorities, and the process can be more complicated depending on the company’s assets and liabilities.
Can a California attorney be my LLC/S-Corp registered agent?
Yes, a California attorney can act as your LLC/S-Corp’s registered agent in California with a physical address.
Can a California LLC/S-Corp hire a non-owner as a registered agent?
Yes, both LLCs and S-Corps in California can hire a non-owner as their registered agent with a physical address in the state.
Does an LLC or S-Corp in California need to have minutes from meetings held by its owners?
It’s recommended that LLCs and S-Corps in California maintain minutes from meetings held by their owners for legal and tax compliance purposes, but it isn’t mandatory.
Do California LLCs and S-Corps have different employment tax requirements for their owners?
Yes, LLC owners in California are generally considered self-employed and must pay self-employment taxes, while S-Corp owners may be able to reduce Social Security and Medicare taxes depending on their salary level.
Can LLC owners in California receive dividends from their business?
In a multi-member LLC, members shouldn’t receive dividends, and instead must pay themselves a salary and federal taxes. In a matter of a single-member LLC, they will risk having their business be taxed like a C-Corp.
What are some disadvantages of forming an S-Corp in California?
S-Corps in California have tighter regulations than LLCs and may require more paperwork, as well as limitations on the number of owners and the type of deductions they can take on their taxes.
Can a California LLC tax election affect the company’s employee benefits?
Yes. The way an LLC chooses to be taxed in California can impact the employee benefits they offer.
Are there many differences between LLC and S-Corp governance in California?
Yes, particularly due to distinctions over how owners are allocated representation, limitations on ownership and compensation, distributions of earnings and tax planning.
Is an LLC operational agreement valuable to have in California?
Yes, to make sure the LLC operates appropriately for registrations, regulation, handling internal governing matters, and tax optimization for current, future and exiting owners etc.
How many LLCs or S-Corps are formed in California in a year?
From 2015 to 2019, just under 250,000 LLCs, and under 40,000 S-Corps were formed annually in California.

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Conclusion

Ultimately, choosing an LLC and an S-Corp in California will depend on your business goals, management preferences, and tax considerations. It’s essential to consult with a legal or financial advisor to determine which structure is best for your business in California and help you navigate the formation process. Making an informed decision will set your business up for success and ensure you’re well-positioned for growth and profitability.

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