Going out on your own and starting your own business is a big step. We can help you decide whether your new business should be a sole proprietorship, limited liability company (LLC) or S corporation and then help you with the business formation.
SOLE PROPRIETORSHIP. This is often the first option for most people starting a small business. It’s easy to set up. All you need is a tax identification number, a business bank account, a business license and a fictitious business name if you are operating under a name other than your own. The downside of a sole proprietorship is it gives you no liability protection and all of your net income will be subject to payroll tax.
LIMITED LIABILITY COMPANY. An LLC can be set up as a partnership (more than one owner), a single member LLC (only one owner, or if in a community property state like California, a husband and wife can choose to be treated as one owner), or a corporation. An LLC can provide a barrier between business creditors and your personal assets. In most cases, a multi-member LLC is taxed as a partnership and a single member LLC is taxed as a sole proprietorship. An LLC electing corporate status can be taxed as a standard corporation or as an S corporation.
To establish an LLC, you must file Articles of Organization with the Secretary of State, file a Statement of Information, execute an Operating Agreement, get a tax identification number, open an LLC bank account and get a business license. It requires a lot more effort than a sole proprietorship, but if you want to better protect your personal assets from business creditors, then an LLC can give you much better protection. Net profits will be subject to payroll taxes.
However, California makes an LLC not so attractive for businesses that gross more than $250,000. An LLC must pay the state a minimum $800 per year for the privilege of being a California LLC. In addition, California levies a gross receipts tax, which is an additional $900 for an LLC that grosses $250,000 or more and $2,500 for an LLC that grosses more than $500,000, and it goes up from there. Because of the gross receipts tax, we usually don’t recommend our small business clients use an LLC if they will gross more than $250,000. In most cases, we don’t recommend an LLC for an operating businesses. But we do recommend an LLC for our clients who want to protect passive investments, like owning rental real estate.
S CORPORATION. An S corporation is usually the best choice for a California small business. To establish an S corporation, you must file Articles of Incorporation with the Secretary of State, file a Statement of Information, get a tax identification number, execute Bylaws, Organizational Minutes, issue Share Certificates, open a corporate bank account and get a business license. This takes a bit more effort than an LLC. The corporation will have to pay a minimum $800 state tax, but unlike an LLC, an S corporation does not have to pay the gross receipts tax. In addition, with an S corporation, you can pay yourself partly with W2 salary, which is subject to the payroll tax, and partly with a shareholder distribution. Shareholder distributions are not subject to payroll taxes, so by separating your W2 salary from your shareholder distributions, you can save in payroll taxes.