There are several types of business entities that an individual may want to consider forming, including C corporations, S corporations, professional corporations, limited liability companies (LLCs), limited partnerships (LPs), limited liability partnerships (LLPs), general partnerships (GPs), and sole proprietorships. Each of these entities are distinct and have unique benefits and consequences that you will want to consider before choosing which entity to form.
A C corporation is a business entity best suited for business where a substantial amount of the profit earned will be reinvested back into the company. This is because C corporations receive “double taxation” tax treatment. Double taxation means that the net income of the corporation is taxed at the corporate level, and the corporate profits distributed to the shareholders as dividends are taxed to the shareholders as income, even though taxes on the income was already paid at the corporate level. A C corporation provides protections to the owners individual assets, because creditors can only attach to the corporation’s assets, unless the “corporate veil is pierced”.
An S corporation that has made a subchapter S election with the IRS, allowing for “pass-through” tax treatment. This means that, unlike C corporations, the corporate profits or losses are taxed to the shareholders and not taxed at the corporate level. In order to make a subchapter S election, several requirements must be met, including having no more than 100 shareholders, the corporation must be a California corporation, and there can only be one class of stock.
A professional corporation can either be formed as a C corporation or an S corporation. In order to form a professional corporation, the business must be engaged in an approved business activity, including accounting, medicine, dental work, architecture, engineering, and the law, among others. In order to be a shareholder in a professional corporation, an individual must be licensed to practice the profession being practiced by the professional corporation. Shareholders of professional corporations are protected from the nonprofessional service obligations of the professional corporation, including, rent, loans, and contracts.
Limited Liability Companies (LLCs)
A limited liability company (LLC) is similar to an S corporation with fewer formal requirements in formation and to maintain their LLC status with the State of California. This flexibility allows an LLC’s owners (members) to agree on the how to organize the company’s management, rights of the members, allocation and distribution of profits and losses, and transferability of membership through the adoption of an operating agreement. Most businesses that qualify as a professional corporation are unable to be formed as an LLC.
A general partnership requires two or more individuals engaged in a business for profit. This type of entity may require the owners to obtain a fictitious business name, a business license, and to enter into a partnership agreement to determine how profits and losses are split. This type of entity does not provide limited liability to the owners of the business.
A sole proprietorship is the most basic business entity to form, and is merely an individual operating a business. This type of entity offers the least protections to the business owner, but is also the easiest entity to form. Some of the requirements for forming a sole proprietorship may include obtaining a fictitious business name and a business license.
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