In California, a Limited Liability Company (LLC) and a Corporation are two of the business structures that offer liability protection to the owners of the company. Although they are very similar, they have many important differences too. If you’re wondering which corporate structure you should choose, read through this article. This article is a comparison between LLCs and Corporations.

Business Incorporation in CA

What does it Mean to Incorporate a Business in California?

When a business incorporates, its business structure moves from being a sole proprietorship or general partnership to a structure wherein it becomes a separate entity from its owners. The law recognizes the company by its state of incorporation, which may either be a Limited Liability Company or a Corporation. There are various subtypes of corporations but the most popular types in California are S Corporations (S Corps) and C Corporations (C Corps). All of these 3 corporate structures offer the advantage of being protected from personal liability and having increased credibility with customers. As much as there are many advantages with these types of business structures, each also has its disadvantages.

1. Limited Liability Company

Limited Liability Companies in California

The owners of a Limited Liability Company are referred to as members. An LLC protects its members from being personally liable for any actions of the company. This means that if a lawsuit were to arise concerning the business, your personal assets are kept safe.

Unlike corporations, LLCs offer more flexibility in the management of the business. In corporations, there is a management structure that needs to be followed, like having directors oversee the major decisions that need to be made while officers are assigned with the daily operations of the business. LLCs, on the other hand, do not have this strict structure. The members may manage the daily operations or they can have an individual or a team assigned with the task.

In an LLC, pass-through taxation is applied. This means that taxes are not paid at the business level. Instead, the company’s income and losses are reported on the members’ tax returns. Taxes are paid, therefore, on the individual level only.

Unlike S Corporations, LLCs have fewer restrictions on who can be an owner of the business and on how many owners there can be. Moreover, LLCs have fewer state-imposed annual requirements and other formalities compared to corporations.

2. Corporations

Corporations in California

There are basically many types of corporations in California but the most popular types are S Corporations and C Corporations. The type of corporate structure you choose depends on the goals of your business.

Similarities between S Corporations and C Corporations

Basically, a C Corp is a regular corporation and an S Corp is a C Corp that has applied for a special tax status with the IRS. The S Corp gets its name because it is defined in Subchapter S of the Internal Revenue Code. In order for a C Corp to become an S Corp, it has to file Form 2553 with the IRS and meet all the S Corporation guidelines.

Both S Corp and C Corp offer liability protection to their owners. The shareholders, who are recognized as the company’s owners, are not personally responsible for any debts and liabilities that the business may incur. This is because both types of business structures are considered by the state as separate legal entities from their shareholders.

S and C Corporations have similar management structures. They both have shareholders, a board of directors, and officers. The shareholders are the owners of the corporation, and they elect the members of the board of directors. The directors are responsible for overseeing and directing corporate affairs and decision-making. Officers, on the other hand, who are elected by the directors, are responsible for the day-to-day operations of the company.

Articles of incorporation, also known as a certificate of incorporation, need to be filed with the California Secretary of State in order to form both C and S Corporations.

Differences between S Corporations and C Corporations

S Corps differ from C Corps in many ways, and the most prominent difference is in their taxation. C Corporations are separately taxable entities. Taxes are paid at the corporate level and therefore you must file a corporate tax return (Form 1120). In cases wherein a corporation’s income is distributed among the shareholders as dividends, double taxation may apply because dividends are considered as personal income. Tax, therefore, is first paid on the corporate level and then again at the individual level on dividends.

S corporations, on the other hand, are pass-through entities just like LLCs. S Corps need to file an informational federal income return (Form 1120) and no tax is paid at the corporate level. Instead, the profits and losses of the company are “passed through” the corporate level and reported on the shareholders’ personal tax returns. All taxes are paid at the individual level.

In terms of ownership, C corporations do not have restrictions while S corporations do. S Corps are allowed to have no more than 100 shareholders and all of them should be US citizens or residents. S Corps cannot be owned by C Corps, other S Corps, LLCs, partnerships, or trusts. Unlike C Corps, S Corps are not allowed to have more than one class of stock.

Other Differences between LLC, S Corps, and C Corps.

The advantage of being an S Corp is that business owners can use the losses of the company as deductions on their personal tax returns. Unlike C Corps, which are taxed as a completely separate tax entity, S Corps can also provide savings on self-employment, security, and Medicare taxes. S Corps allows the shareholders to offset their non-business income with the losses from the business.

LLCs and C Corps do not have restrictions on the number of allowed business owners but S Corps do. S Corps should have a maximum of 100 shareholders who are all residents and citizens of the United States. Unlike LLCs and C Corps, S Corps cannot be owned by C corps, other S Corps, LLCs, and certain trusts.

Many developing businesses in California often choose to be C corps instead of other business structures because the stockholders can hold different classes of stock interests including preferred and common stock. This variety in classes of stocks allows different levels of dividends. This also attracts venture capitalists and investors.