LLC vs S Corp California: what is their difference? In this guide, we'll compare LLCs and S corporations from a California perspective to help you decide which option is best for your business.
- LLC is easier and cheaper to set up than S Corporation.
- LLC owners must pay self-employment taxes for all income. S corp owners may pay less on this tax, provided they pay themselves a “reasonable salary.”
- In case of bankruptcy, both LLC and S Corp protect members' or shareholders' personal assets from creditors.
If you're starting a business, there are several considerations to make before deciding how to structure your company. One of the most important decisions is whether to form an LLC or an S corporation.
What is an LLC?
The Limited Liability Company (LLC) is a business entity that can be formed in any state but is usually formed to protect the personal assets of its owners.
Provides Personal Liability Protection
The owners of an LLC are called members and they have limited liability for the debts and obligations of the company. This means you can keep your personal assets separate from your business assets, which protects them in case something goes wrong with your company.
Can be used for any Kind of Business
An LLC can be used for any kind of business, including professional services, manufacturing, and retailing.
This Business Entity is Easy to Form and Manage
The LLC is a popular choice for small business owners because it combines many of the best features of corporations and partnerships. It's easy to form, easy to manage, and flexible enough that you can decide how much or little control you want over your business finances.
What is an S Corp?
A Subchapter S Corporation, or simply S Corp, is a type of corporation that has filed with the IRS to be taxed as a pass-through entity; this means that the income and expenses of the corporation are passed on to its shareholders who then report them on their personal tax returns as if they were wages or other income.
LLC vs. S Corporation: What's the Difference?
The members of an LLC own the LLC, have voting rights and can participate in management decisions. They can be individuals or other businesses. Managers are appointed by member vote to run day-to-day operations on behalf of all members.
While an LLC can have unlimited numbers of members, S Corporation is limited to 100 or fewer. The owners of an S Corp are called shareholders. They can only be USA citizens while LLCs can have members all over the world.
S corporations are limited to estates, trusts and some organizations. Check with your state as rules differ with where you come from.
LLC vs S Corporation: Formation
The other primary difference between the two is in how they are formed. The process for forming an LLC is simpler than forming an S corporation and generally takes less time.
Formation of an LLC is a process that involves filing articles of organization, creating an operating agreement, getting an Employer Identification Number (EIN), and applying for licenses.
Articles of Organization
The articles of organization are the documents filed with the Secretary of State to officially create an LLC. The articles must contain basic information about the company, including its name, address and number of shares.
The operating agreement is a contract between all members of the LLC that sets forth how they will operate their business together. It describes issues such as how decisions are made, what happens if one member wants to leave, how profits or losses will be split up, and how much each member must contribute to cover expenses.
The operating agreement should be signed by all members before any money is contributed or any business activity takes place.
An EIN is similar to a Social Security number for businesses. It identifies companies for taxation purposes.
You may also need licenses for your business if you're planning on selling products or offering services in certain areas within your state or city limits.
Forming an S-Corporation
The process of forming an S corporation is similar to forming a regular corporation, but there are some important differences. The most significant difference is that you must file IRS Form 2553, to convert your company to an S corporation.
File Articles of Organization
The first step in forming an S corporation is to file articles of organization with your state's Secretary of State or other designated agency.
The article must include the name of the corporation, its registered agent (the person who will receive legal documents on behalf of the company), and the number and type of shares you plan to issue.
File The Corporate Bylaws
Next, you'll need to draft corporate bylaws that include detailed rules on how your business will be run
Once adopted, these rules will govern all future decisions made by your board, including who may vote at meetings, how many votes each shareholder has, how much notice must be given before a meeting takes place and how much time should pass between meetings (at least 6 months).
Issue Stock Certificates
Another step is to issue stock certificates to each shareholder listed on your articles of incorporation or operating agreement. Stock certificates are legal proof that an individual owns shares in an S corporation.
The management structure of an LLC is fairly flexible. Unlike an S or C corporation, LLCs are not required to have a board of directors or even officers. The company can be managed by the members, who are often referred to as managers. LLC owners or Members can take on the roles of secretary or treasurer if desired or needed.
In contrast, S corporations are required by law to have a board of directors and at least one officer (president. The board of directors is responsible for running the corporation.
LLCs vs S Corporations: Taxation
In most cases, both LLCs and S corporations are considered "flow-through" entities for tax purposes, meaning that all income and losses from operations pass through directly to the tax return of each member/shareholder (or owner).
However, an LLC can choose to be taxed like a corporation if it meets certain criteria set forth by the IRS.
Limited Liability Companies vs. S Corporation: Operations
LLCs are the most common type of business structure for small businesses, and they're also a popular choice for freelancers.
Corporations are more complex and expensive. Corporations must file annual reports with the state and federal governments, which costs money and can be time-consuming.
Corporations have restrictions on selling or transferring ownership shares which makes selling your business more complicated than selling an interest in an LLC.
Which is better, LLC or S-Corp for California?
The two most common types of business structures in California are LLCs and the S corporation. Both have their benefits, but they also have their drawbacks. You need to decide which structure will work best for your business.
LLC is Better for a Business Owner
The LLC has become a popular way to structure businesses, in part because of its flexibility and in part because it is not subject to the same rules as corporations. The LLC form is also attractive to certain businesses that have complex ownership structures.
No Restrictions on Numbers of Members in LLC
An LLC is similar to a partnership in that there are no restrictions on how many members an LLC can have (unlike with an S Corporation). Any number of people can form an LLC, who then share in its profits and losses. This allows for flexibility in the number of shareholders and makes it easier for businesses to grow.
On the other hand, an S Corp is limited to 100 shareholders at any one time. This means that if your business grows beyond 100 shareholders, you'll have to switch from an S Corp to another type of entity such as an LLC.
Do LLCs or S Corps Pay More Taxes?
No, LLC or S corps do not pay more taxes. S Corporations are similar to regular corporations in terms of governance, but they're taxed differently. Like LLCs, S corporations don't pay federal income taxes at the corporate level.
Instead, their profits "pass-through" to the personal tax returns of shareholders who report them on their personal returns as if they were ordinary dividends. This can save money on taxes compared to having all profits taxed at the corporate rate of up to 35%.
Can I convert my California LLC to an S Corp?
Yes. You can convert your California LLC to an S corp.
File IRS Form 2553 with the Internal Revenue Service (IRS). This form allows you to change the tax status of your business entity from a regular corporation or limited liability company (LLC) into an S corporation or "small business" corporation.
If you want to convert your California LLC into an S corporation, you need to make sure that your company meets all of the following criteria:
- It must be a domestic business entity (that is, it was formed in one of the 50 states).
- Its shareholders must be U.S. citizens or residents who have U.S.-source income from the business.
- The total number of shareholders cannot exceed 100 (this includes individuals, corporations, and other entities) unless they're all qualified subchapter S subsidiaries or qualified subchapter S trusts.
Trusted Business Formation Services
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