Many first-time business owners are caught by surprise when learning about the numerous different types of businesses available to them. Filing a business under certain categories can provide financial and legal benefits to owners. To ensure you’re making the right decisions when filing the initial paperwork and drafting contracts for your business, consider contacting a California business lawyer to determine which path is right for you.

What Is the Difference Between LLCs and S Corporations?

LLCs, also called Limited Liability Companies, are not corporations. In order to start one, owners must file a document called the Articles of Organization that provides basic information about the company, like its address and the names of the owners. Once this is filed, a separate document called the operating agreement is created that defines how the business will run and how owners split profits and losses.

S corporations are a form of corporation and are beholden to those rules. They are formed by establishing Articles of Incorporation, which are similar to Articles of Organization but also include information about shares. Additionally, a board of directors must be elected, and a set of bylaws must be drafted. There must also be at least one board meeting and one shareholder meeting, and the stock must be divided before the corporation is official.

Both LLCs and S corporations are effective ways to start a new business, but they typically have different requirements and benefits. Here are some key differences between LLCs and S corporations:

  • Membership Structure: S corporations offer more flexibility than LLCs regarding ownership of a company. S corporation membership is most affected by who owns the most shares of a company and can be changed by selling those shares. All members of an LLC must agree if members are removed, added, or given different levels of ownership.
  • Management Structure: LLCs are more flexible in how they can be managed than S corporations. An LLC can either be managed by the members themselves or by an elected board, while S corporations must be run by a board of directors and cannot be managed by shareholders.
  • Compliance Requirements: LLCs often have fewer requirements for compliance than S corporations do.

What Business Entity Is Right for My Business?

Ultimately, deciding which type of business entity to register your company as depends on the individual business itself. Here are some characteristics of certain businesses that might help you make your decision:

  • Changing Owners: If you anticipate multiple owners leaving and joining the company over the lifespan of the business, it might be beneficial to register as an S corporation. This may allow for an easier transition and avoid having to constantly get approval from every owner.
  • Does Not Meet S Corporation Status: If your business is owned by another organization, has multiple classes of stocks, has more than 100 shareholders, or has shareholders who reside outside of the US, you might not qualify to file as an S corporation.
  • Outside Funding: Some businesses are interested in obtaining funding from banks or other sources of external capital. Banks and other investors tend to prefer loaning money to corporations rather than LLCs because it is easier to do so via the purchase of stocks. Corporations are also subject to stricter requirements that sometimes make them safer for investors.
  • Potential C Corporation Status: If you’re interested in eventually obtaining C corporation status to offer different stock options, it is easier to start your business as an S corporation. Changing an S corporation to a C corporation is considerably easier than changing an LLC to a C corporation.

Deciding between an S corporation and an LLC can be complicated and requires extensive planning before forming a business. Contacting a business lawyer can help you understand your options and make the most effective decisions for your business and its owners. Seeking legal counsel can also help avoid issues down the road that could lead to litigation.

FAQs:

Q: Is It Better to Start as an LLC or S Corp?

A: The decision to start as an LLC or S corp depends on numerous factors. S corps typically involve less paperwork than LLCs. There are also different rules on who can be owners of an LLC and an S corp. Both entities allow owners to have a “pass-through” tax status in which they do not have to pay two different levels of taxes; instead, they only pay one tax in the form of personal income tax.

Q: Do You Have to Pay an $800 California S Corp Fee Every Year?

A: Unlike other states, California requires both LLCs and S Corps to pay an $800 annual tax fee. This amount can increase based on the amount of income a business generates. This also applies to businesses that are located in other states but earn at least 25% of their income in California. If your business was formed between January 1, 2021, and January 1, 2024, you may be able to waive the $800 for the first year of the business’s existence.

Q: Why Would Someone Use an LLC Instead of a S Corporation?

A: LLCs are more flexible in terms of how much ownership each member has of the business. Owners of an LLC can assign different profits and losses regardless of the percentage of ownership they have of the company. Corporations of any size must allocate profits and losses strictly based on the percent ownership each member has of the company. LLCs also have less stringent requirements to meet than S corporations.

Q: What Are the Disadvantages of a California LLC?

A: LLCs usually cost more to establish than other forms of businesses. In California, this includes a $70 application fee and at least an $800 annual tax, dependent on the business’s revenue. It is also more difficult to transfer owners under an LLC because all members must agree to add new owners or shift the ownership percentages. Shareholders of a corporation can sell their shares to change their ownership amount.

Get Efficient and Responsive Business Support From The Myers Law Group

The Myers Law Group has over 80 years of experience in business litigation, business formation, and corporate governance. Our attorneys take an individualized approach by creating a unique plan for every client. Schedule a consultation today to learn how you can benefit from The Myers Law Group’s assistance when forming your business.