LLC vs. S Corp in California

As an entrepreneur, you normally have more choices than a standard employee. Though this has many benefits, making the right choice on your own can be difficult. If you’re just starting as a business owner, you’re probably wondering which business entity is best for you.

Do business owners fare better if they start limited liability companies (LLCs)? Is an S Corporation the way to go? The answers to these questions depend on your specific business needs.

If you don’t know what to choose, this article can help you understand the advantages and disadvantages of an S Corp vs an LLC in California.  

LLC vs. S Corp: Which is better in California? 

The first thing to understand about an LLC vs an S Corporation in California is that an LLC is a separate business structure, and an S Corporation is a tax status. You form an LLC by filing specific paperwork with the state of California. And you elect to give your business S Corporation tax status by filing paperwork with the IRS. Electing an S Corporation status can be far less formal than starting an LLC. But an S Corporation doesn’t normally provide the same protections that many seek from an LLC.

What are the tax differences between LLCs and S Corps in California?

Tax differences between LLCs and S Corporations can vary.

Federal Taxes

When deciding whether you want to run an LLC or S Corp in California, you have a few federal tax considerations.

Pass-Through Taxes

Remember that both enjoy pass-through taxation at the federal level. Pass-through taxation means that LLCs and S Corporations don’t pay federal income taxes as entities. Only their owners pay federal income taxes on their shares of the business income. When comparing an LLC vs an S Corp vs a C Corp in California, a C Corporation is subject to double taxation. Double taxation means that C Corporations must pay federal income taxes at the entity level, and their shareholders must pay personal income taxes for their shares of the business distributions.  

Self Employment Taxes

A big difference between federal taxes for LLCs and S Corporations is how flexible they can be regarding self-employment taxes. In many cases, an LLC member must count their share of the LLC’s income and their guaranteed payments as part of their wages for self-employment tax. Shareholders in an S Corporation usually have more flexibility. An S Corporation shareholder can often set their own reasonable salary for their services to be subject to self-employment taxes. Shareholders can then define the rest of their business income as distributions of shares.

For example: If a shareholder’s distributions from business income are $70,000, they might be able to set $50,000 as their wages and claim the rest as a $20,000 distributive share. However, if a dispute arises, the court normally has the last say about whether $50,000 is a reasonable salary under the circumstances. 

California Taxes

LLCs and S Corporations must pay regular taxes to the California Franchise Tax Board. S Corporations pay a 1.5% tax rate on their income and a quarterly franchise tax. LLCs pay an annual tax and an LLC fee based on their income. 

How do California LLCs and S Corps handle liability protection?

In general, the liability protection you have when running an S Corporation depends on the underlying business entity you elect to give S Corporation status. If you have a general partnership with S Corporation status, you and your partners are personally responsible for the partnership’s legal and financial troubles. If you have an LLC with S Corporation status, you can enjoy the liability protection applicable to all LLCs. An LLC normally does far more to protect you from personal liability. In general, the financial and legal issues of an LLC can’t touch its members’ personal assets. 

How do California LLC and S Corp ownership requirements compare? 

LLCs and S Corporations are alike in the fact that there are rigid rules about ownership. LLC ownership rules are rigid because, in many cases, an LLC can accept a new member only when all other members consent. S Corporation ownership rules are rigid because only certain individuals can be shareholders. (However, an S corp can own other businesses.) Among those not allowed to be S Corporation shareholders are:

• Partnerships
• Corporations
• Non-resident immigrants 
• Certain financial institutions
• Insurance companies
• Domestic international sales corporations

S Corporations can have only one class of stock, and they can’t have more than 100 shareholders. 

Whether either of these options is a good fit can be contingent on your financial and operational needs. It’s probably best to speak to legal and financial professionals before deciding what kind of business to run.

Which is easier to file in California: LLCs or S Corps?

When it comes to an LLC vs an S Corp in California, an S Corporation normally has easier filing requirements. Many businesses that elect to be S Corporations need to file only one or two initial forms to elect the status, and then file the appropriate tax returns each year. LLC owners must file Articles of Organization to start their business. LLCs must then file the appropriate yearly tax returns and Biennial Reports to keep the business legally compliant.

You don’t have to let legal compliance obligations scare you away from owning an LLC. Our Worry-Free Compliance Service can help you stay on top of your compliance deadlines and includes up to two business amendments per year. 

Can I convert my California LLC to an S Corp? 

If you’re at this point in our article and you’re thinking that S Corporations and LLCs are equally viable choices for your new business, there’s good news: you can run your business as both!

How do I convert my California LLC to an S Corp? 

After you form your LLC with the state, you can elect to give it S Corporation status by filing Form 8832 and Form 2253 with the IRS.

Do I need to change my designator if I do?

No. You can still call your business an LLC after converting it to an S Corporation. This is because an S Corporation is a tax designation, not a separate business entity. 

What is the best time for an LLC to elect S corporation status?

It depends on your needs, but the best time to elect S Corporation status is usually when you’re ready to fulfill all the eligibility requirements that come with the status. Your readiness might be contingent on writing an Operating Agreement with solid rules about membership or making enough profit to hire a good accountant. Once you’re ready, you have two months and 15 days to file S Corporation paperwork in the tax year in which you want the status to begin.