S-Corp Vs LLC California: Everything You Need to Know

What Is an LLC?

An LLC is a limited liability company. In California, a limited liability company offers special protection against the owner of the business’ personal assets. Therefore, it allows the owner to keep their finances separate from the business in the event of a lawsuit or other types of litigation. What’s more, LLCs operate as their legal entity and might have tax benefits as well. Ultimately, an LLC is a type of legal structure for a business. They require a separate tax filing number, known as an EIN. An LLC can also be a single-member LLC or a multi-member business and the owners of the company have to be publicly listed.

LLCs are often used for small and medium businesses because they function as a better partnership if you want to have multiple members of a company. However, even sole proprietors can benefit from the tax benefits and liability protection that an LLC has to offer.

What Are the Types of LLCs?

Several types of LLCs exist in California. From single-member LLCs to limited liability partnerships (LLPs), you have plenty of options to choose from. Choosing the type of LLC you want to start can determine whether or not you can be taxed as an S-corp. For this reason, it’s important to choose the right type of LLC for your unique business situation.

It’s also important to note that not all LLC types are available in California. For example, you can’t have an LLC with anonymous owners or a series LLC in California. These types of LLCs can function as foreign LLCs but not as California LLCs, so keep this in mind if you plan on starting a business in California. Before you even consider the difference between an LLC and an S-corp it’s important to consider the type of LLC you would be choosing.

How Much Does it Cost to Start an LLC in California?

The cost to start an LLC in California varies based on your business type and what you plan on selling. However, you’ll always have to pay the $800 franchise tax as well as business license fees. Other taxes may also apply to your business if you operate in specific industries. Ultimately, expect to pay between $800 and $1,500 to start an LLC for the first year. We include lawyer fees, registered agent fees, and more in this price estimate. That said, we recommend having more money set aside to prevent any problems.

What Are the Advantages of an LLC in California?

LLCs come with several advantages you need to consider. Depending on the type of LLC the advantages can also change. For example, some anonymous LLCs allow you to keep your name off the business to keep your personal information private. On the other hand, other LLCs, like a series LLC, can help you establish one LLC as a main company and have branch companies beneath it to keep everything under one umbrella.

Ultimately, LLCs are flexible legal entities and you can make them work well for your needs. Learn more about the advantages of an LLC below.

Liability

First and foremost, an LLC protects you from general liability. With a great insurance policy and LLC protection, you don’t have to worry about people coming after your assets in the event of a lawsuit. This liability protection can also protect other members of the company and even its employees. If you plan on having a large company this can help everyone rest easy while you’re doing business.

Credibility

Another benefit of LLCs is credibility. While some proprietorships can be advantageous for tax purposes, people tend to trust an LLC more. For example, one study found that people are more willing to purchase goods or services from LLCs when compared to partnerships, sole proprietorships, and other business models. This credibility can make or break your business, so keep this in mind when choosing a legal structure for your company.

Flexibility

An LLC is one of the most flexible legal structures for businesses that you can find. It allows you to have multiple owners, and transfer ownership when someone passes away, and there are no limits on the number of members. Furthermore, LLCs allow you to distribute profits between your members with flexibility and without any problems. The last thing to note about flexibility is that you have several tax filing methods you can choose from. In fact, you can even file as an S-corp.

What Are the Disadvantages of an LLC in California?

As a legal entity, an LLC is one of the better options you can choose. However, that doesn’t mean it’s perfect. In fact, if you don’t properly separate funds or protect yourself properly, you may have to pay more in taxes and you can even leave yourself exposed in the event of a lawsuit. Learn about some of the disadvantages of LLCs below.

Annual Filing

As an LLC in California, you have to file with the California Secretary of State (SOS) every year. This means that you’ll have to ensure that your company remains compliant and that all of your paperwork is in order.

Another part of the filing process is having a registered agent. This registered agent needs to be available during normal business hours five days per week, so you have to choose someone reliable. Annual Filing also may include other documents and LLCs have more paperwork in general when compared to other legal entities in California.

Taxes

When it comes to an LLC taxes can be an advantage or a disadvantage of the business structure. This is because it makes sense to use an LLC in California for some people but not for others. For example, you have to pay a $800 franchise tax in California, so if you don’t plan on making a lot of money it might be better to avoid creating an LLC to avoid the tax. You also have to provide a detailed report of your income and expenses and keep a record of each transaction. LLCs also have to pay the full amount of Social Security tax and pay all taxes on any profit.

Holes in Personal Liability Protection

Most people believe that they’re completely safe when they establish an LLC. While this can be the case, it’s not always true and you may find that you have increased liability if you don’t manage your money properly. For example, someone who doesn’t keep their business funds separate from their personal funds can get into trouble for commingling.

This can lead to lawsuits that expose your personal assets. Therefore, it’s important to make separate accounts to avoid any problems with your funds.

What Is an S-Corp?

An S-corp is not a legal business structure like an LLC. Instead, it’s a tax classification. Therefore, it only influences how you pay taxes. This means that you can be an S-corp as a professional LLC, LLC, or any other legal structure as long as you meet the requirements.

That said, most small corporations choose to be S-corps and some LLCs can also benefit from being taxed as an S-corps. S-corps are beneficial for several reasons but they can also have disadvantages. Therefore, it’s important to consider whether or not this structure is right for you before you consider being taxed as an S-corp.

So, what is an S-corporation? The short answer is a tax filing status that gives you more flexibility than an LLC.

What Are the Requirements for an S-Corp in California?

In order to be taxed as an S-corp you need to meet specific requirements. Depending on the type of legal entity you have these requirements will change. For example, corporations will have different rules than LLCs when it comes to being taxed as an S-corp. Understanding these requirements will help you determine if an S-corp is right for you.

Some of the requirements you should be aware of include:

• The business has to operate in the United States and be a US business
• No more than 100 owners or shareholders
• Shareholders should be individuals but some trusts and estates can also be approved
• Shareholders can’t be a corporation or another type of business
• There can only be one class of stock available

Meeting these requirements shouldn’t be challenging for new businesses but as your company grows you should consider an account for guidance. Once you meet these requirements you can file with the California Secretary of State and form your new S-corp.

How Much Does it Cost to Start an S-Corp?

Starting an S-corp in California isn’t too expensive. Expect to pay $100 to start an S corporation and $15 for a handling fee. You can file these in person or online with the California Secretary of State. For this reason, you don’t have to worry about too many startup costs and you can do this as an LLC or as a sole proprietorship.

When starting an S-corp you also have to consider the franchise tax. It can be as low as a couple of dollars and as much as $200,000 depending on your company’s revenue. This is because you have to pay a 1.5% flat rate on the company’s profits.

What Are the Benefits of an S-Corp in California?

S-corps have benefits that vary based on the business structure. Therefore, it comes down to the type of business and the legal entity that the S-corp tax designation is being applied to. For this reason, most of the benefits have to do with taxes.

Fewer Taxes at the Shareholder and Corporate Level

One of the most common reasons for a business to be taxed as an S-corp is to avoid paying extra taxes or more taxes. A great example is how corporations benefit from S-corp status. A corporation benefits from an S-corp because you don’t have to pay taxes at both the corporate and shareholder level. This can reduce the tax burden for smaller corporations.

Less Franchise Tax with Small Revenue

It’s also important to note that you can pay less franchise tax as well. This is because S-corps are taxed at a flat rate of 1.5% of their revenue in California. Therefore, if your company makes $50,000 or less you only have to pay $750 in franchise tax. This is $50 less than the amount of money that LLCs have to pay in franchise tax. However, as S-corps grow this can become more expensive.

Asset Protection

Like an LLC, S-corps usually protect shareholders from any liability. This applies to the shareholder’s personal assets, credit, and cash. While it doesn’t offer immunity from bad habits or bad business, if you don’t commingle your funds you shouldn’t have any issues with liability when forming an S-corp.

What Are the Disadvantages of an S-Corp in California?

S-corps are a great way to file in California but they’re not perfect. The biggest issue is that you run the risk of being audited and paying more taxes if you generate too much revenue. Learn more about the disadvantages below.

Higher Audit Risk

S-corps have a higher audit risk than LLCs due to their pass-through tax benefits. This means that the IRS will pay closer attention to S-corps instead of the average traditional LLC. To combat this problem we recommend working with a reliable bookkeeper even if they’re more expensive. This can help you remain organized and prevent an audit from happening. However, even if it does you shouldn’t have any problems if you keep a record of your transactions.

Expensive Accounting

Accounting is one of the biggest problems with starting an S-corp. While it won’t hinder your company’s performance it will likely cost you more due to the complexity of the taxes you have to claim and how you claim them. Instead of having a small accounting fee or being able to use personal tax filing software, there’s a good chance you’ll need a professional CPA.

Member Limit

Another disadvantage is the lack of members that an S-corp can have. The structure of an S-corp limits it to only 100 shareholders. Therefore, companies that want to grow beyond 100 members will have to change their business structure to do so.

Higher Franchise Tax

Last but not least, the franchise tax is back. While this isn’t guaranteed to happen when you start an S-corp, you have to pay 1.5% of the company’s revenue in taxes. For smaller S-corps, this can be a blessing but for larger S-corps, this can become a big problem.

Is an S-Corp or LLC Better in California?

Whether or not an S-corp or LLC is better in California comes down to your needs and the type of business you plan on starting. Learn more about an S-corp vs an LLC through some direct comparisons between how taxes, costs, and salaries are handled below

S-Corp vs LLC Salaries

Salaries can be handled in similar ways whether you have an S-corp or an LLC in California. The key difference is how the salaries are paid and how taxes are paid on those salaries. Unlike an LLC, S-corp owners can take a salary from their profits. For example, if the company makes $120,000, the owner can pay themself $100,000 and they only have to pay income tax on that $100,000 instead of the rest of the income. It’s important to note that S-corps are under more scrutiny with salaries than LLCs due to people taking advantage of the tax benefits. For this reason, many tax professionals recommend the 60/40 rule to maximize profits as reasonable compensation.

On the other hand, an LLC owner has to pay taxes on all of their profits, including the 15.3% self-employment tax. Therefore the way salaries are handled is different between S-corps and LLCs in California. Unfortunately, LLC owners aren’t able to take a salary like people who own S-corps.

S-Corp Vs LLC Cost

The cost of an S-corp and LLC can be similar but some key differences will determine if they’re right for you. S-corps typically have higher compliance costs and accounting costs due to the more complicated tax filing process but they can save owners money on taxes. Therefore, they’re usually cheaper to form than an LLC in California.

On the other hand, LLCs have more upfront costs but you don’t have to worry about expensive accounting (if you stay small). LLCs will also have lower operating costs over the long term as well.

S-Corp Vs LLC Taxes

When it comes to taxes, the main difference is that an S-corp is taxed as a pass-through company. In short, this means that an S-corp passes the tax liability off to the shareholders. Then, shareholders have to file the tax liability on their tax returns. This usually results in shareholders claiming a percentage of their revenue as income and that can come with some great tax breaks, especially when you pair it with the ability for S-corps to not pay Social Security and Medicare taxes on all of their revenue.

On the other hand, an LLC doesn’t have to be taxed this way. It can be taxed as an LLC or choose to be taxed as an S-corp. Ultimately, which option works best for you depends on your situation. We recommend talking with a CPA before choosing a legal entity and tax filing methods for your company.

Can an LLC Be Taxed as an S-Corp?

Yes, an LLC can be taxed as an S-corp. This is something that varies case by case because having an LLC that’s taxed as an S-corp can either be beneficial or problematic. To do so an LLC has to be converted into an S-corp within 15 days from when the company was formed. When this is done the IRS will treat an LLC as an S-corp but when it comes to liability and the company’s legal status it will remain an LLC. To go through with this process you need to fill out the 2553 form available on the IRS’ website.

While an LLC can be taxed as an S-corp the same is not true for an S-corp that wants to be treated as an LLC. This is because S-corps are not legal entities, so they need a different business structure to operate. That said, you can convert an S-corp to an LLC by liquidating the S-corp and distributing all of the assets to the shareholders. Then, all of the shareholders can come together and use their assets to form the new LLC.

Advantage of LLCs Taxed as S-Corps

The advantage of an LLC that’s taxed as an S-corp is the way that the money flows through the company to the shareholders instead of the owner. If an LLC has multiple shareholders, this can reduce the tax liability for the owner of the LLC. For this to work the owner of the LLC needs to have a salary that’s paid to them from the LLC. For these reasons, it can help you save money on your tax bill, even if you report more income.

Another advantage of an LLC taxed as an S-corp is that the LLC can function more like a corporation without needing to have directors, officers, and other formalities that corporations have to have in California. For someone who wants to experience the tax benefits of an S-corp without having to deal with a full board of members, this is a huge benefit.

Disadvantages of LLCs Taxed as S-Corps

LLCs taxed as S-corps aren’t always the best thing for them. For example, it’s more challenging to file the right paperwork and remain compliant. Additionally, S-corps can’t have more than 100 shareholders, so if you plan on expanding to a larger company you’ll have to change your S-corp status down the line. For some, this can be a lengthy process and it may not be worth it to start as an S-corp for your LLC. Another disadvantage you need to prepare for is an IRS audit.

An audit can make or break your business and your liability can’t save you. For example, if your taxes aren’t in order you can end up being removed from the company or the company will close. Another disadvantage is that your accounting fees will likely increase because it’s a more complicated business structure.

S-Corp Vs LLC in California FAQ

Have more questions about an S-corp or LLC in California? Find more answers to some of the most common questions below.

Do You Have to Pay an $800 S-Corp Fee Every Year?

Yes, most S-corps, corporations, and LLCs are subject to the $800 franchise tax that California has. However, there are some ways around paying this tax. For example, if your company was formed within 15 days of the end of the year, you don’t have to pay the $800 tax. Additionally, you can avoid the tax if your company doesn’t turn a profit in a given calendar year. While you don’t always have to pay this tax you have to consider if the reason you’re not paying the tax is worth it to you.

Does an S-Corp Need a Business License?

Yes, an S-corp needs a business license in California. An S-corp needs one of these licenses because each county in California requires you to have a license to sell goods or services. On top of a license, your S-corp likely also needs permits and other documentation to legally operate in California. Therefore, you should consider applying for a business license if you plan on operating as an S-corp in California.

Does California Recognize Foreign S-Corps?

California does recognize foreign S-corps and LLCs. You have to file with the California Secretary of State to get approved but once you have that approval you shouldn’t have any issues with your S-corp designation. You will need to provide a Statement and Designation by a Foreign Corporation and a certificate of good standing from the state in which the S-corp was founded.

Choose Between S-Corp and LLC in California Today

One of the most important things you have to do when starting a business in California is choose between an S-corp and an LLC. In fact, you may even want to choose if you want to create an LLC and have it file as an S-corp. Ultimately, all three options are viable depending on your needs.

We recommend spending some time with a professional before you commit to any business models. When it comes to taxes and creating your brand the last thing you want to do is make a mistake during the formation process. Unfortunately, doing so can leave a crack in the foundation of your business and leave you exposed to liability, increased tax liability, and much more.