One of the most important decisions a business owner can make when establishing a new business is whether to establish the business as a California Limited Liability Company, LLC, or as the California S Corporation, S-Corp. There are different degrees of personal protection offered by each option. There are tax advantages and disadvantages to each, and either may impact the daily complexity expected of the business operations. It’s important to know the differences between an LLC and an S-Corp when making the decision as to which will be best for your business. WB Law Group discusses the difference between these options as they relate to businesses being established in California.
Initial Considerations
Deciding between an LLC or an S-Corp comes down to three main considerations:
- How can I limit my taxable income associated with the business?
- What specific circumstances need to be addressed in the establishment of the business?
- How can I limit my personal liability and the liability of any other owners of the business?
The final consideration is the most important one. Ultimately, your business should always be established to protect yourself. There are usually formalities associated with maintaining limited liability, but they often outweigh the negative consequences of being completely and personally responsible for an incident associated with your business.
After developing an understanding of your initial considerations, you may want to next consider how many owners the new entity will have. Owners are referred to as “members” in an LLC and “shareholders” in an S-Corp. In situations involving only one owner and a simple business plan, you may be able to go over the stipulations of each and determine the best designation yourself. In more complex situations, particularly with multiple owners and a more grandiose business plan, it’s usually better to hire a reputable business attorney to look over your business plan and guide you on the correct course of action. Oftentimes avoiding taxes, understanding special circumstances, and foreseeing personal liabilities is best performed by an attorney working in tandem with a tax professional such as a CPA.
Comparison of LLCs and S-Corps
There are many differences between LLCs and S-Corps worth considering. Here are just some:
- Formality: S-Corps are much more formal than LLCs. There is a term called “piercing the corporate veil” which refers to finding errors within the incorporation process by an entity that feels it has been wronged by the corporation. If an entity can “pierce the corporate veil,” they are able to sue for individual assets in addition to those owned by the corporation. In more complex organizations, S-Corps are generally preferred as they protect businesses more, but they are more difficult to maintain than LLCs.
- Taxation: S-Corps do not generally pay federal income taxes. Instead, any income or losses are divided among and passed to the shareholders pro rata in accordance with their ownership interest. Shareholders then report the income or losses for taxation. This is a way of avoiding double taxation, which is common in other corporations. There are, however, strict regulations for eligibility and set up fees that may make an S-Corp not worth it compared to an LLC. In making the decision, the size of the company and how much money it expects to make is an important consideration and how much in taxes will be spared by doing the S-Corp long term versus the LLC. S-Corps, for example, do not pay an additional California tax on gross receipts over $250,000. LLCs, on the other hand, certainly do.
- Management: S-Corps have a very formal structure, and as such, are more complicated in restructuring than LLCs. If your business is likely to experience a lot of changes shortly after its inception, an LLC may be a better option. An LLC is member or manager handled, whereas an S-Corp is comprised of officers, directors, and shareholders who each play separate roles. A seemingly simple change of role in an S-Corp may actually be rather complicated, involving the transfer of stock or shares in the company and extensive paperwork and attorney involvement. This is where it comes back to keeping anything from “piercing the corporate veil.”
Need an Attorney in Establishing an LLC or S-Corp?
WB Law Group is a reputable business litigation firm with experience in matters involving California law, such as establishing an LLC or S-Corp. Having a reputable attorney on your side for these matters will protect your personal assets from your corporate assets while ensuring you don’t overdo it with an established business that is too difficult to maintain for your needs. If you feel you need legal representation, we are happy to review your business needs and provide consultation.
For questions, or to schedule a consultation, contact us today at (559) 431-4888.