1. Forming an S Corporation in California
2. What Is an LLC?
3. LLC Pros and Cons
4. What Is an S Corporation?

Forming an S Corporation in California

California S corp tax describes the beneficial tax treatment of a business that elects to be treated as an S corporation by the Internal Revenue Service (IRS). LLCs, partnerships, and corporations can opt for this tax status by filing IRS Form 8832, Entity Classification Election.

If you are starting a California business and plan to opt for S corp taxation, make sure you indicate the existence of only one class of stock in your articles of incorporation. Although you can offer different voting rights, S corporations must not offer multiple stock classes. You should also review restrictions on the number and types of shareholders that S corps allow.

California businesses that elected federal S corporation status do not need to file separately to have this status honored in California. At both the state and federal level, S corporations are subject to pass-through taxation. At the federal level, this means that corporate income is not subject to federal tax but is instead taxed on the individual tax returns of each shareholder. In California, however, an S corporation is also taxed by the state at the corporate level as well as when it is reported by shareholders (double taxation).

If you have a California LLC that has elected S corp taxation, your company may also be subject to entity-level tax. For this reason, before starting a business in California, consider working with a professional tax advisor to determine the most advantageous business entity.

California S corporations must also file Form 100S to report California-source income, which is subject to a franchise tax (minimum $800). This form is due during the third month after the tax year closes, on the 15th day of that month.

What Is an LLC?

An LLC, or limited liability company, benefits from the same pass-through taxation treatment that applies to S corporations. An LLC also limits the owners' liability for business debts and financial obligations. LLCs are a popular business entity because they provide simple operation, few administration requirements, and flexible profit-sharing in addition to tax benefits.

Before deciding whether to form an LLC or S corporation, think about the features that are most important for your business. A knowledgeable corporate attorney can help you determine how each type of entity will impact your specific situation.

An LLC shares a default structure like that of a partnership or sole proprietorship. The main difference is that while an LLC owner's personal liability is limited to his or her financial investment in the company, sole proprietors and partnerships do not enjoy limited personal liability. However, even in an LLC, owners are still responsible for accidents, negligence, and other tort actions.

LLC Pros and Cons

The main benefits of an LLC include:

  • Ease of operation, including a simple registration process and minimal start-up costs
  • No requirements for formal annual meetings and minutes
  • Pass-through taxation, though some states (including California) do require corporate taxation of this income.
  • Few restrictions on profit-sharing, including the freedom for members to contribute in different proportions as well as in capital and/or sweat equity.

Drawbacks of an LLC include:

  • Dissolution when a member dies or files for bankruptcy
  • Owners must pay 15.3 percent self-employment Medicare and Social Security taxes
  • Must only have two out of four of the following characteristics: Limited liability, continuity after the death of a member, a centralized management structure, and freedom to transfer ownership interests. A business that desires more than two of those elements must register as a corporation.

What Is an S Corporation?

An S corporation is a business entity that has elected Subchapter S tax treatment from the IRS. The owners of an S corporation have limited personal liability, though a plaintiff may be able to go after personal assets in some legal circumstances. 

Although an S corporation enjoys the benefit of pass-through taxation, shareholders who work for the company must be paid a reasonable salary before profits are distributed or risk having additional earnings classified as wages by the IRS. This salary is subject to Social Security and Medicare taxes. However, S corporation owners do not have to pay self-employment tax.

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