How a Limited Liability Company is Formed

Filing for an LLC or a S Corporation?

An LLC is formed by filing certain documents with the California Secretary of State. In an LLC, the equivalent of a corporation’s articles of incorporation is called articles of organization. The articles of the organization should include information about the members of the company. All LLCs in California are required to have at least one member. Each member is considered an owner of the company. Just like the shareholders of a corporation, the LLC members’ liability towards the company is limited to what he or she has contributed to the business’ capital. The members of an LLC do not need to be individuals. They can be corporations, partnerships, or other LLCs.

In an LLC, the equivalent of a corporation’s shares or stocks is called membership interest. A member’s membership interests represent an ownership interest in the LLC. Generally, the value of one’s membership interest determines the extent of his or her control over the LLC.

LLCs are basically managed by their members. The extent of management depends on the weight of their membership interests. Although the members are generally the managers, many LLCs in California, however, have operating agreements that provide for a manager or a board of managers to run the operations of the company. It is the members of an LLC that appoints a manager, and also have the power to remove him or her from that position.

All LLCs need to have an operating agreement. An operating agreement is a document that determines, defines, and limits the rights of the members. In formulating an operating agreement, the members must discuss thoroughly, agree properly, and carefully draft the documents to avoid problems in the future. Hiring a competent business attorney in California is a good way to make sure that all the details of an operating agreement are covered correctly.

How an S Corporation is Formed

An S corporation or S Corp is a type of corporation that has chosen to be taxed under Subchapter S of Chapter 1 of the Internal Revenue Code. To form an S Corp, a business needs to file articles of incorporation with the California Secretary of State. A federal tax ID and an S election should also be obtained.

For a corporation to be taxed under the Subchapter S of the Internal Revenue Code, the shareholders should obtain Form 2553: Election by a Small Business Corporation, have it signed by all of the shareholders, then file with the IRS.

For a business to qualify to become an S Corp, it needs to be an eligible entity (e.g. domestic corporation, LLC, etc.). Corporations cannot qualify to become an S Corp if they have more than one class of stock. Furthermore, they should not have more than 100 stockholders, and they all must be US citizens or residents. The stockholders of an S Corp are recognized as the owners of the company. Lastly, the business’ profits and losses must be allocated proportionally among its shareholders, according to each one’s interest in the company.

Management and Operation: S Corp vs. LLC

The Difference Between LLCs and S Corps

S Corporations are managed by a board of directors that are elected by the company’s stockholders. The daily operations of the business are managed by the officers, who are appointed by the board of directors. Limited Liability Companies, on the other hand, have more flexible management options. LLCs can be managed by either the members or a set of appointed managers. The style of management should be laid out in the operating agreement and include details of management duties and responsibilities.

Differences in Taxation

Employee Medicare and FICA taxes are not affected, regardless of the corporate structure of a company. But federal income tax treatments vary in both LLC and S Corp business structures. It is important to note that the corporate tax rate is generally lower than the personal income tax rate, but in a C Corp, double taxing applies. Double taxation happens because a C corporation is taxed on its profits, and then when the profits are divided among stockholders, they are taxed on their dividends.

S Corps, on the other hand, can bypass this double taxation. An S Corp should report the entire income of the company on the personal income tax returns of its stockholders. The distribution should be in proportion to the ownership of each shareholder in the company. Moreover, when this is done, the losses incurred by the S corporation should also be reported on the stockholders’ personal income tax return, which will consequently reduce their tax liability.

In an LLC, taxation is more flexible. An LLC can choose to be taxed as a C corporation or as an S corporation.

The shareholders of an S corporation need to report income on Form 1120S, salaries on Form W-2, and the profit distribution on Schedule K-1. In an LLC, the members need to report income on their personal tax Form 1040 Schedule C or Form 1065 and Schedule K-1 for the profit distributions. If an LLC chooses to be taxed as a C Corp, tax reporting of income should be on Form 1120, salaries on Form W-2, and the profit distribution on Form 1099-DIV.

Business Legal Counsel in California

Find Competent Business Lawyers in California Today

For a better understanding of Limited Liability Companies and S Corporations, you need to have the assistance of a competent business lawyer in Orange County, California. Gale & Vallance is a law firm based in Orange County that can assist your business in forming an LLC, an S Corp, or any other business entity. They also offer other legal services that your business might need, such as corporate record keeping, legal assistance in business transactions and contracts, etc. Contact them today at +1 (714) 634-4838!