Having options is great, but having too many options can be overwhelming, especially if you’re a small business owner interested in a higher degree of business ease and looking to take advantage of as many tax benefits as possible. If you need to make a serious decision that concerns the future of your business, you need to get the inside scoop. Here we focus on two most popular business structures: Limited Liability Companies and S Corporations.
If you’re determined to resolve the LLC vs S corp conundrum, you need to know what exactly are the differences between the two and whether the advantages of one outweigh the advantages of the other.
Why do business owners choose LLCs & S Corps over other business structures?
One of the major benefits of S corps in California is the prospect of saving money on taxes. It comes as no surprise that this feature holds most appeal for small business owners.
As a pass-through entity, this business structure enables business owners to pay annual taxes for their share of the business’s activity. It works like this: the income and any deduction are passed through from the S corp to its owners. Any deductible expenses will go toward decreasing taxable income or count as credits/deductions.
This is why many small business owners choose to have their business treated as an S corp for tax purposes. Aside from saving money on taxes, this structure offers small businesses the coveted limited liability protection.
But then again, LLC is also a pass-through entity known for its tax efficiency and operational flexibility. It too offers liability protection. So what’s the catch?
What is the difference between LLC and S corporation in California?
The tax rates for S corps in the State of California are the higher of $800 or 1.5% of net income (unlike C corps which are taxed at $800 or 8.84% of net income, whichever is higher). A major difference between LLCs and corporations is that taxes for corporations are based on net income, while taxes for LLCs are based on gross receipts. California also charges LLCs the annual tax of $800.
The liability limit for S corp shareholders and LLC members differs as well. The liability of LLC on the whole is limited to the company assets and the liability of individual LLC members is typically limited to their investment in the company. The liability of shareholders in an S corp is limited as well, although the so-called piercing of the corporate veil remains a real risk and therefore a legitimate concern.
What are the pros and cons of LLCs and S corps?
The pros of LLC:
- Higher operational ease (fewer forms to submit, lower start-up cost),
- No formal meeting requirements,
- Fewer profit-sharing restrictions.
The cons of LLC:
- Shorter duration in case of bankruptcy or member death,
- Prolonging duration requires conversion to another business structure.
As far as S Corps are concerned, aside from a higher level of shareholder protection in terms of liability mentioned above, you can count on the following pros:
- Potential tax savings on account of pass-through taxation,
- No self-employment tax,
- The possibility of business expense deductions,
- Independence from shareholders who die, sell their shares or leave the company.
But there is a price to pay for these perks. The cons of an S corp boil down to a lower level of operational ease when compared to an LLC:
- Demanding operational requirements,
- Time-consuming paperwork.
How do you decide between the two types of business structures?
First you need to determine which features are most important to you and your business. After all, the needs of each business are different and unique. You need a business structure that will offer a balance between the legal protection of you and your assets and benefits in terms of taxes and daily business operations.
And here’s the good news: you can have the best of both worlds and combine the benefits of LLCs and S Corps. As long as your LLC meets the requirements, you can request S Corp status. That way, your LLC will remain an LLC in the legal sense, but will be treated as an S Corp for tax purposes.
Make sure to consult an experienced tax consultant before making any decisions that will affect your future and the future and prospects of your business.
Make forward-thinking decisions and keep stress at bay
So you have questions about the process of incorporating a business in California, want to have a clear understanding of business structures in general or need to decide between setting up a California LLC vs S corp set-up? You’re not the only one, but more importantly: you’re not alone! We’re here to show you the ropes and get you on the right path.
Whether you need us to help you incorporate your business, give you a hand with the technicalities and administration process or assist you with various related services, we’re always ready to provide a quick response. Call David York’s Tax Service here in sunbathed San Diego and make steps that translate to business success today!