Making the decision to start your own business can feel exciting and overwhelming all at once. In addition to getting essential operations up and running, you’ll need to pay attention to several important legal and financial considerations, including choosing the appropriate legal structure that is a good fit for your business.
The type of business entity you choose will determine the extent of your personal liability, the types and amounts of tax you will owe, and the types of paperwork you will be required to file with government agencies.
Below, we’ll discuss the primary types of business entities in California and how an attorney at Business Estate & Tax Attorneys, P.C. can help you determine which structure is the right choice for you.
What Are the Major Types of Business Structures in California?
Forming a business often begins with a basic question: What type of business structure is right for your venture? Having the right type of business entity will make it easier for your business to operate, grow and thrive. The entity you choose may make your business more attractive to customers, vendors, investors, lenders and possible strategic partners.
When you start a business in California, you can choose from multiple types of entities including:
- Sole Proprietorship
A sole proprietorship allows an individual to own and operate a business. The owner enjoys all profits of the business and has total control over the business. However, the uncomplicated nature of a sole proprietorship also has its drawbacks. Because there is no legal distinction between sole proprietors and their business operations, sole proprietors take on personal responsibility for all debts, obligations, and other liabilities of the business.
This means creditors of a sole proprietorship can go after the personal assets of the owner. A sole proprietor is also not legally protected if someone decides to sue their business.
All profits generated by a sole proprietorship are subject to a self-employment tax. A sole proprietorship is not considered a separate legal or tax entity. As a result, owners report their income on their personal 1040 income tax returns.
- General Partnership
A general partnership (GP) can be formed by two or more individuals who expressly or implicitly agree to go into business together for profit. While it’s always recommended to create and file a written partnership agreement, GPs can be formed without one.
As in sole proprietorships, profits and losses in GPs go directly to the partners in proportion to their share of ownership. A partnership allocates its profits and losses to its partners, who then report this information on their individual tax returns.
Each partner in a GP faces unlimited personal liability for the business. Business creditors can pursue assets of partners when they come to collect, and each partner can be held individually and jointly liable for the actions or obligations of any other partner.
To register a GP in California, the partners file a Statement of Partnership Authority with the California Secretary of State’s office. Registration is not mandatory, however.
- Limited Partnership
A California limited partnership (LP) involves both general and limited partners. General partners in an LP have management control over the business, a proportional share of all business profits and losses, and individual liability for all partnership debts and obligations.
Limited partners in this type of structure have little or no management control over the LP, so their liability is limited based on the amount they invest in the partnership. Limited partners must take care to avoid comingling their personal and partnership assets.
The nature of an LP makes it easier to attract investors since general partners are not forced to give up management control and limited partners are able to invest without risking personal assets. In this way, limited partners are comparable to corporate shareholders.
LPs are taxed the same as general partnerships: profits and losses are passed to partners, who report them on their individual income tax returns. Profits and losses are allocated based on their amount of ownership interest.
LPs must also pay a minimum annual state franchise tax. However, LPs pay no federal business income taxes. Unlike with GPs, the formation of an LP requires a formal filing with the California Secretary of State’s office including the disclosure of select information about your business.
- Limited Liability Partnership
A limited liability partnership (LLP) is a relatively new type of legal structure in California that is currently only available to certain types of licensed professionals, including accountants, lawyers, and engineers.
The structure of an LLP protects individual partners from personal liability for business debts, obligations of the partnership, and negligent acts committed by other partners. There are no general partners in an LLP.
Profits and losses of an LLP are passed through directly to the partners in proportion to their share of ownership. Partners in an LLP must pay taxes on their individual tax returns. The LLP itself is subject to the state minimum annual franchise tax. LLPs are not required to pay federal business income tax as long as they meet specific criteria that allow them to avoid incurring corporate taxes.
Unlike limited partners in an LP, LLP partners have the right to make management decisions about the partnership’s operations. These entities must register with the state.
- Limited Liability Company
A limited liability company (LLC) provides members with protection from business liabilities and the option to allow profits and losses to be passed on directly to members. LLC members’ personal assets are not typically vulnerable to a lawsuit against the business.
California LLCs are owned by their members, who can manage the company directly or pass that responsibility on to designated managers.
LLCs also have flexibility to be taxed as a sole proprietorship, partnership, C corporation, or S corporation. Nontheless, California LLCs are also required to pay the state’s minimum annual franchise tax.
Owners must establish an LLC Operating Agreement to define the relationship between members. LLC members must also make certain disclosures to the government, which are then made available to the general public. Further, LLCs are not able to issue stock the way a corporation can, thus making investment opportunities more limited.
- S Corporation
An S Corporation is a unique type of corporation in which business owners elect to treat the company as a pass-through entity, which means S corporations are not subject to federal business income taxes. However, shareholders in an S corporation are still protected from personal liability if the corporation is sued.
Owners of an S corporation who perform services for the business are considered employees as well as owners of the business. They must be paid a reasonable wage compared to employees in similar positions in their profession. The owners report these wages as regular W-2 employee wages. They also receive a share of profits, and they are taxed on these distributions. Dividing the income in this way can sometimes allow a business owner to save in self-employment taxes.
An S corporation can attract investors by selling stock in the corporation, though S corporations are not permitted to go public the way C corporations can. S corporations must disclose substantial business information to government agencies and prepare specific types of tax filings.
- C Corporation
C corporations are the most common and well-known types of business entities. These traditional companies are owned by shareholders, who are protected from liability for the company’s business losses and obligations. California C corporations are managed by boards of directors, which appoint corporate officers to manage the company’s business operations.
Owners of C corporations can file for business tax deductions for things like business equipment, insurance, and employee expenses. C corporations can sell ownership shares including making a public stock offering to accumulate capital for expansion or to retire debt.
C corporations are required to file formal articles of incorporation and to disclose select business information to the government. Profits are typically taxed separately under the corporation’s name.
The most significant drawback to forming a C corporation is the concept of double taxation. The profits of a corporation are taxed twice, once as business profits and again as stockholder dividends through the capital gains tax.
How to Choose the Right Entity for You
To determine which type of California business entity is right for your situation, you should consider the following factors:
- The type and pace of growth that you envision for your business
- The level of personal liability you are willing to accept on behalf of your business
- How your business will be taxed at both the state and federal level
- How complex it will be to establish your business as a legal entity
- Whether you and other owners want to retain primary control of the business
- Whether you intend to pursue external funding from investors or banks
- The type of licenses, permits, and regulations with which your business may be required to comply
Assisting with General Business Operations
At Business Estate & Tax Attorneys, P.C., helping with your business formation needs is only one of the services we provide. We are committed to help you with the legal side of the day-to-day operation of your company as well if you need us.
Our firm can provide legal assistance for a wide variety of business operations needs, including employment matters, property issues and regulatory problems. We can also stand with your company when it faces legal disputes by efficiently and expeditiously pushing for cost-effective solutions to resolve expensive litigation and other legal issues.
Among the business operational issues that our firm can help with include the following:
- Drafting and executing corporate resolutions
- Keeping minutes for board and corporate meetings
- Drafting and enforcing independent contractor agreements
- Drafting and enforcing employment agreements
- Drafting employee handbooks
- Preparing employee counseling statements and advising your business on employee disciplinary matters
- Helping your business establish employment performance review and evaluation procedures
- Drafting and executing deferred compensation agreements
- Drafting and enforcing non-disclosure agreements, non-compete agreements, and non-solicitation agreements
- Reviewing and executing equipment lease agreements
- Reviewing and executing commercial real estate lease agreements
Analyzing and Structuring Merger, Acquisition & Buyout Opportunities
At some point on your business’s journey, you may find it necessary to consider a merger with, or acquisition of, another business or you may need to explore questions and legal issues if another business wants to buy your company.
Business mergers, acquisitions and sales can be legally complex and time-consuming. Business Estate & Tax Attorneys, P.C. can provide your company with the legal advice you need to successfully navigate these important crossroads in your business career. We can help ensure that any corporate transaction proceeds as smoothly as possible and that your business interests are fully protected.
Among the M&A legal matters we can help you with include:
- Buy-sell agreements
- Equity purchase letters of intent
- Equity purchase agreements
- Pledge agreements
- Redemption agreements
- Asset purchase agreements
Our firm can also guide you throughout an M&A or buyout process by:
- Helping you seek out and evaluate transaction partners
- Helping you field requests to exercise redemption or buyout clauses
- Helping you negotiate deal terms and term sheets
- Helping you draft and execute appropriate protections such as non-disclosure agreements and exclusivity agreements
- Assisting you during due diligence process (including requesting due diligence from the other party and responding to due diligence requests)
- Advising you through board, shareholder and partner approvals
Critical Tax Planning for Your Business
Business Estate & Tax Attorneys, P.C. will devise the best possible tax strategies for your business. We will work diligently to lower your business’s tax liabilities and help to ensure that your business complies with local, state and federal tax laws by helping you with:
- Electing business taxation status (such as disregarded entity status, partnership, Subchapter S, or Subchapter C)
- Preparing and filing tax returns
- Consulting on payroll taxes and withholdings from employee paychecks
- Helping structure retirement and benefit plans for yourself or your employees
- Crafting and overseeing the operation of employee equity plans
- Paying use and excise taxes
- Collecting sales tax on sales
- Taking advantage of the timing of income and expenses
- Declaring depreciation of assets
- Using qualified business income deductions
The tax laws provide businesses with several tools to reduce tax liabilities. However, the tax codes are complex, and they can also pose traps for the unwary and uninformed. Failing to collect and remit a required tax or taking the wrong deduction can lead to legal problems and expenses for you and your business.
Let us advise you on your business decisions and help you develop strategies that minimize your tax burdens. We can provide counsel to ensure that you collect and pay the taxes your business owes under the law.
How an Orinda Business Attorney Can Help
The Orinda lawyers at Business Estate & Tax Attorneys, P.C. have the legal knowledge and experience needed to help you make the best decisions for yourself and your business. We provide competent, responsive professional services to California business owners who need help planning for the future.
Contact us today for a free consultation to discuss your situation with one of our qualified business attorneys. At Business Estate & Tax Attorneys, P.C., we will provide clear information about your options and assist you in making the best decisions for your business.