Researching LLC vs. sole proprietorship California options? Deciding which business structure to establish depends on issues such as liability protections, management goals, taxation laws, ownership, and funding considerations, just to name a few.

Starting a New Business: LLC vs. Sole Proprietorship

Both sole proprietorships and partnerships are common law entities with no state filing requirements. They offer unlimited liability and pass-through taxation where you pay business-related taxes on your personal income taxes. Limited partnerships (LPs) in California must:

  • Have detailed partnership agreements
  • Hold annual meetings
  • Pay the required franchise tax at the end of each fiscal year.

With a limited liability company (LLC), you must file documents with the secretary of state and pay a state franchise tax in California, which is $800 per year. LLCs are flexible business structures with various ownership arrangements. Owners are referred to as “members,” and each member enjoys liability protections similar to those offered to corporations. An LLC enjoys pass-through taxation by default. However, members can choose to have the business taxed as a C corporation.

There's also another option for professionals in California: the limited liability partnership (LLP). LLPs are only reserved for professionals such as accountants, architects, and lawyers who tend to work with other partners. In an LLP, each partner shares liability for one another's debts. However, each is personally protected against a partner's misconduct, including negligence or fraud.

S Corporation Versus C Corporation

If you own an LLC, you can choose to be taxed as either an S corp or a C corp if the business qualifies. To quality for C corp status, your business must:

  • Hold annual meetings
  • Keep meticulous records
  • Have adequate capitalization
  • Keep personal and corporate assets separate.

In a C corp, managers and shareholders enjoy limited liability for the company's debts. However, they may be liable for debts when certain formalities are not observed, such as in the cases of misconduct or fraud. C corps are taxed as their own entities, and then shareholders are also taxed on dividends, resulting in double-taxation.

Most LLCs are taxed as S corporations. To qualify as an S corp entity, a company must have no more than 100 shareholders and must meet other IRS criteria.

Sole Proprietorships Versus LLCs

A sole proprietorship is the most popular business option in the United States because it's the easiest to establish. Compared to LLCs, sole proprietorships are:

  • Less expensive
  • Less complex
  • Demand less paperwork to get started. 

You simply start business transactions with the required permits and licenses. 

Establishing an LLC takes more time, money, and effort than a sole proprietorship, but it also comes with certain advantages:

  • An LLC is a distinct legal entity.
  • LLC members are not personally liable for company debts or legal judgments.
  • LLC owners are only responsible for their own financial contributions to the business.

However, if you like being your own boss and don't mind being liable for all business-related liabilities, a sole proprietorship is a good option. If you prefer liability protection, consider a single-member LLC.

Starting an LLC as a Sole Proprietor in California

California allows businesses to operate as a limited liability company or a sole proprietorship, but never both. Essentially, a sole proprietorship is a legal entity that one person owns. There is no legal distinction between the owner and the business. Therefore, the owner is responsible for all business activities, including debts and profits.

An LLC is an unincorporated entity with limited liability protection for the owner. The biggest advantage to having an LLC is that your personal and business assets are separate. Therefore, you aren't personally responsible for business-related debts should a lawsuit arise.

In cases where you want to convert your sole proprietorship to an LLC, you cannot transfer existing liabilities unless previous obligations are amended.

To form an LLC in California, register your business name with the state. If you used a “doing business as” (DBA) name for your sole proprietorship, consider using it for your LLC. Prepare an official articles of organization and file the document with the secretary of state. The articles must include your LLC name, an official statement acknowledging the LLC can only be used for legal business purposes, and the contact information for your registered agent in California.

Regardless of whether you own a sole proprietorship or choose to create an LLC, you must pay state and federal income taxes on all business income.

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