- How To Form A Corporation
- Limited Liability Company
- “S” Corporation
- “C” Corporation
- California Agent for Service of Process
The form of your new business is an important decision. Below is a business entities comparison detailing the main differences between a “C” Corp, “S” Corp. and a Limited Liability Company. A California limited liability company can be a sole proprietorship, a partnership or a corporation. All California corporations start out as a C Corporation unless IRS Form 2553 is filed designating the corporation to receive tax treatment as a pass-through entity consistent with Subchapter S of the Internal Revenue Code. All shareholders of the C Corporation must consent to the filing of IRS Form 2553. IRS Form 2553 can be filed at any time the shareholders choose to designate the tax treatment as pass-through.
California Limited Liability Company
Limited liability companies can be classified as a sole proprietorship, partnership or corporation. LLC’s have become a very popular business form given that members or owners liability is limited to their investment in the LLC. Generally owners and members are shield from debts and liabilities of the LLC. The cost of maintain an LLC should be less than that of a S or C corporation. No stock is issued and annual meetings to not have to be held with written minutes. Articles of incorporation are filed with the California Secretary of State and an operating agreement is executed.
LLC’s have what is called “Flow Through Taxation” or “Pass-Through” or a “Fiscally-Transparent” entity. Income flows through to the owners/investors and avoids the double taxation and dividend tax problem of a “C” Corp. See below under “C” Corporations for more information about double taxation. The LLC’s registered as partnership are considered nonentities and must pay a minimum state tax of $800. LLC’s registered as corporations must pay a minimum state tax of $800 and will have a corporate tax rate of 8.86%.
LLC’s are also taxed on revenue as follows:
Revenue of $250,000 or less: $800 annual minimum tax + $0.00
Revenue of $250,000 – $499,999: $800 annual minimum tax + $900 = $1,700
Revenue of $500,000 – $999,999: $800 annual minimum tax + $2,500 = $3,300
Revenue of $1,000,000 – $4,999,999: $800 annual minimum tax + $6,800 = $6,800
Revenue of $5,000,000 or more: $800 annual minimum tax + $11,790 = $12,950
Each owner/member who can legally bind the LLC or who spends more than 500 hours a year on the LLC’s business you should has to pay the self-employment tax on pass-through income in additions to any compensation received as an employee.
If you want to set up an employee stock purchase plan you are out of luck with an LLC. Only an S or C corporation can set up an Incentive Stock Option Plan in which employees do not have to pay taxes when they exercise the stock options.
LLC’s may have one or more owners with different classes of owners as well. A key feature of an LLC is the LLC may be owed by business entities or a combination of business entities and individuals. The tax structure of the LLC will be similar to that of an S corporation, but the LLC is not limited to the ownership restrictions of the S Corporation. See below under “S” Corporations for more information about the ownership limitations of S Corporations.
California “S” Corporations
S Corporations are formed by filing articles of incorporation, bylaws, a statement of information and stock is issued. Annual director and/or stockholder meetings must held with written minutes. S Corporations are subject to the state minimum tax of $800 whether active or not. S Corporations will also be subject to a 1.5% on profits, NOT revenues like an LLC. If you look closer at the number you are better off with an LLC once the S Corporation reaches $768,000 in profits. A problem all of us would like to have. That is assuming the S Corporation has any profits after salaries, benefits and bonuses.
Like an LLC and C Corporation owners enjoy limited liability from creditor or claims against the corporation.
Unlike an LLC, if you are a shareholder of an S Corporation and only receiving pass-through income you do not have to pay the self-employment tax. You do have to pay self-employment tax on income you receive as compensation for your services. An owner/employee must pay themselves a reasonable amount (salary) for what they are doing compared with their industry where they live. A drawback though is the amount that is contributed to a retirement account is calculated based upon the salary paid, not the pass-through income you receive that is not subject to the self-employment tax.
A limitation of the S Corporation is that there can only be one class of stock unlike a C Corporation or the various forms of ownership an LLC can have. Every owner of the class of stock has the same voting rights and percentage of power. An LLC in comparison can have someone with 2% of ownership, 12% of voting power and 13% of the profits and losses.
The main issue with C corporations is what is called double taxation. If you are the owner/shareholder of the C corporation you will be taxed on your salary received and any additional profits you receive in the form of a dividend. The corporation will have paid corporate profits taxes and the dividend is taxed also. This is the doubt taxation problem that can be avoided with an S corporation with pass-through tax status.
So why keep the corporation in a C corporation form at all? C corporations can generally accumulate capital better than a S corporation. The tax rate for an individual is generally higher than the corporate tax rate of the C corporation.
C corporations are generally more flexible that S corporations. If you believe your business is going to become a multi-million dollar business that may go public in the future a C corporation would serve your purposes. In the beginning it is probably best to designate the corporation as a S corporation and then convert to a C corporation if it becomes necessary.