Any entrepreneur knows that choosing the right entity for his or her business is an essential first step. There are several factors that a business owner needs to consider before deciding on a specific entity. Selecting the wrong business structure can create problems and can be costly to correct. That’s why anyone in this position would be wise to obtain some small business legal advice. Below is an introduction to this exciting decision.
Choosing the Right Entity in California –
Here’s an overview of the business entity options available from a legal and tax standpoint in California:
- Sole Proprietorship
- Limited Liability Company
- Limited Liability Partnership
As you continue to work through the process of choosing the right entity for your business in California, apply your model specifics to each expanded example below:
The sole proprietorship designation tends to be a good fit for solo ventures. It’s a popular choice for freelancers, independent contractors, and consultants. California does not require sole proprietors to register with the Secretary of State’s office. However, taxes, permits, and licensing requirements must be paid for and obtained where applicable.
Specifics regarding sole proprietorships in California include: Sole proprietorship designations do not require the payment of hefty filing fees.
- There are fewer government regulations and oversight that apply to this structure.
- Closing the business is relatively simple.
The sole proprietor is the primary ‘shot caller.’ Obtaining capital can be difficult relative to other business structures.
Attorneys providing small business legal advice will often tell clients that a unique feature of this structure concerns legal and financial liability. It rests squarely on the shoulder of the owner. The owner should keep personal and business financial matters separate for tax purposes. Unfortunately, this division does not shield personal assets from potential business liability. Additionally, there is no tax benefit to this type of entity.
General and Limited Partnerships
A partnership is also relatively simple to form, and the liability issues are similar. The main difference is that a partnership is a collaboration between two or more people. Each business partner is accountable for legal and financial liabilities at a personal and professional level based upon his or her percentage of ownership.
There are two types of partnerships under this strategy: general partnerships and limited partnerships.
General partnerships are designed to be simple. A contract exists between partners for operational purposes while still allowing for autonomous decision-making in certain respects. It is incredibly important to have your documents drafted by an attorney. The documents will outline the relationship between the parties. Proper drafting and negotiating up front, while the partners are on equal footing is much easier than later on when someone is in a disadvantaged position due to financial problems, illness, or even death.
Limited Partnerships (LPs)
Limited partnerships, or LPs, are a bit more complicated. They are usually comprised of limited and general partners. Limited partners are often known as ‘silent’ investors; they provide capital resources and collect profits without managerial input. General partners are responsible for day-to-day operations.
A properly-formed LP has at least one limited partner and one general partner. The general partners are responsible for liabilities while the LPs are not. As such, LPs often find such a position attractive as an investor. They can also exit without having to dissolve the business.
Corporations are commonly known as ‘C-Corps’ because the nature of their structure is defined by Subchapter C of the Federal Tax Code.
The majority of C-Corporations are publicly traded. Ownership shares are sold to buyers who “share” in the gains and losses of that company. Unlike sole proprietorships and partnerships, corporations are subject to ‘double taxation,‘ in that both the corporation and its owners and shareholders pay taxes on income.
When choosing the right entity for you consider the following factors related to corporations:
- There are no limits to the number of
- A board of directors must be elected to advise the entity.
- Tax and compliance filings are relatively complex.
It’s important to note that shareholders are afforded limited liability protection. Therefore, stock ownership is an attractive option in terms of raising capital
Limited Liability Company (LLC)
A limited liability company, or LLC, is a hybrid business entity. LLC owners enjoy the autonomy provided by sole proprietorships and partnerships with limited exposure to liability like a corporation.
An LLC can have an unlimited number of members, starting with one. Owners are not required to elect a board or hold annual meetings. However, owners are required to draft the articles of organization and an operating agreement before formation.
Subchapter S Corporations (S-Corps)
A Subchapter S is a corporation that provides for 100 or fewer shareholders. It must meet several IRS requirements, but properly-established S-corps enjoy the legal protection of a corporation along with the benefit of pass through taxation to the shareholders. In essence, an S-corporation provides the best of both worlds to small business owners.
To qualify for S-Corp status, the business must meet the following requirements:
- Shareholders must be individuals.
- Shareholders must be legal U.S. residents or citizens.
- Only one class of stock may be issued.
- The business itself must not be subject to specific tax provisions.
- All shareholders must agree to the tax election.
An s-corporation is a corporation that has filed requisite paperwork to be taxed under subchapter s of the tax code. It is important to consult with a tax professional before making this election. There is a revenue threshold at which an s-corporation makes sense for a business owner but it depends on many factors.
Limited Liability Partnership (LLP)
A limited liability partnership creates the same tax and liability benefits as an LLC. Each partner can operate as a general partner and limited partner. This means that the investors can actively manage the business while assuming limited personal responsibility for its debts.
A professional corporation is the only option for certain service professionals that are required to have a license under California law. For example, lawyers and doctors. Only professionals with the requisite licenses can be shareholders of professional corporations. These entities typically provide limited creditor protection, requiring the licensed professionals to protect themselves by carrying adequate professional liability insurance. Shareholders must comply with the California Corporations Code, Business and Professions Code, and any rules imposed by the licensing division for that particular profession.
Factors to Consider When Choosing the Right Entity for Your Business
By now, you may have more questions than answers regarding choosing the right entity in California. That also means that you could benefit from small business legal advice.
A quick list of factors to keep in mind as you work through choosing the right entity in California includes the following:
- Legal and financial liability
- Entrepreneurial experience and capacity
- State and federal tax considerations
- Potential capital needs
- Continuity and transferability
Getting small business legal advice from an attorney in California can help you reduce tax consequences and liability exposure. A California business lawyer ensures that you are following state and federal laws while adhering to the documentation requirements on an initial and ongoing basis. He or she can be a wealth of information on existing and future tax law as well as business strategy.
At Kam Law Firm, we know that there are many options available when choosing the right entity for your business. Let us help you select the best solution for your situation. You can request a free consultation by calling our office at (619) 535-1405 or sending us a message through our online form.