What are the Differences Between a Corporation and a Limited Liability Company in California (Inc. vs. LLC)?
The attorneys of Theta Law Firm are familiar with the formation, maintenance, and dissolution of various business entities in California. For advice on how to form your business or other legal questions relating to your business, please feel free to give us a call or send us an email.
What is a California corporation?
A corporation is an old, well-established, and common form of legal business entity created and regulated under state law. Corporations provide limited liability protection to its shareholders, who are collectively the owners of the corporation. In California, a corporation is managed by a board of directors, which makes the major business decisions and oversees its operation generally. The board of directors also appoints the corporations officers. The day-to-day operations of California corporations are handled by the corporation's officers.
What is a California LLC?
The California limited liability company is a relatively new form of legal business entity that provides for liability protection as well as pass-through tax status, without all of the complications of corporations. In other words, you get the best of both worlds: liability protection of a corporation and no payment of federal income taxes like a sole proprietorship, S corporation, etc. California limited liability companies are owned by their members. California LLCs can be managed by their members, or they can be managed by designated managers. The structure, maintenance, operation, and termination of LLCs is less complex than that of corporations.
What are the SIMILARITIES between California corporations and LLCs?
- Liability Protection: Both limited liability companies and corporations both provide limited liability to their owners (members in the case of an LLC and shareholders in the case of a corporation). If your company gets sued, your personal assets (beyond your investment in the business) are protected. The exception is that there may be some liability on the part of the owner arising from the owner's management of the business.
- Enhanced Credibility: Both LLCs and corporations provide some form of enhanced credibility for their businesses in the eyes of some customers. It may make your business look more legitimate and well-established when your business card says "LLC" or even moreso "Inc." at the end of it.
- Creation: Both are created under state law, but the way in which a corporation is created is quite different from the steps necessary to form an LLC.
- Perpetual Existence: LLCs and corporations can both have perpetual existence.
- Formation: Corporations are created by filing an Articles of Incorporation with the California Secretary of State. Limited Liability Companies are created by filing an Articles of Organization with the California Secretary of State. A complete discussion of how to form a corporation or a limited liability company can be found here: http://www.thetafirm.com/articles.
- Taxation: Generally, corporations are subject to double taxation: (1) profits of a corporation are taxed (2) owners then pay additional taxes on their salaries and/or dividends. With LLCs, on the other hand, profits and losses are passed directly to the members. LLCs do not have to pay federal income tax (assuming the proper election is made), so they are not "double taxed" like C corporations are. However, just as with any business entity, individual owners do need to report income from salaries or their share of the LLC's income. In some cases, it can be advantageous for tax purposes to form a corporation because corporations can take deductions that actually reduce the owner's income. However, both LLCs and corporations must pay California taxes.
- Management Structure: While a California corporation is operated by its board of directors and officers, a California LLC can either be run directly by the owner(s) (called "members") or by designated managers.
- Formalities: Corporations are subject to more requirements/formalities than limited liability companies. For example, corporations hold annual director and shareholder meetings, while LLCs have no such requirement. However, it still is advisable for LLCs to document financial and other transactions of the business for tax purposes in the event of an audit.
- Shareholder Investment: Corporations can sell shares of ownership to build capital and to grow. C Corporations can also go public. LLCs cannot by default issue stock in the way a corporation can. Selling ownership interests in an LLC is more complicated.
Whether you should choose a limited liability company or a corporation will depend on your specific circumstances. You should speak with an attorney and a qualified tax professional before making a decision on which entity to form.
For small businesses who prefer more flexibility and don't plan on going public, an LLC may be the better choice. The fact that LLCs can elect to be taxed as pass-through entities (LLCs don't get "double-taxed" like corporations) makes them very attractive for small businesses.
On the other hand, for a business interested in selling shares of its stock to investors and/or a business that can benefit from various tax deductions available, a corporation may be the better choice. Moreover, some corporations qualify for S corporation status, and can be taxed as a pass-through entity like LLCs.
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