An Introduction to S-Corporations in California: Benefits and Drawbacks
California business owners should understand the pros and cons of S-Corporations so they know whether they want to choose that business entity.
August 24, 2012
An Introduction to S-Corporations in California: Benefits and DrawbacksAmong the many decisions entrepreneurs must make when starting a new business is how to structure the company. Depending on their needs, California business owners may choose from a variety of business entities, including:
-Sole proprietorship
-General Partnership
-Limited Partnership (LP)
-Limited Liability Company (LLC)
-C-Corporation
-S-Corporation
Doing business as an S-Corporation can offer substantial benefits, but it is not without drawbacks.
Tax Benefits of S-Corporations
S-Corporations, like sole proprietorships, LLCs and partnerships, are taxed using a pass-through system of taxation. This means that the company's profits "pass through" to the shareholders' personal income tax returns without being taxed on the corporate level. In contrast, the income of C-Corporations is subject to "double taxation," which means that the C-Corporation pays taxes on profits, and then shareholders who receive distributions, pay individual income taxes on those distributions.
Owners of an S-Corporation can save money on payroll taxes by paying themselves a salary and disbursing the remaining profits as "distributive shares." Because distributive shares are not subject to the same taxes as payroll expenditures, this may reduce the overall tax liability for the company's profits.
In certain circumstances, the owners of S-Corporations who have a sufficient tax basis, can write off corporate losses against their other income.
Limited Shareholder Liability
Unlike sole proprietorships and general partnerships, the owner's of S-Corporations generally do not have personal liability for business debts and liabilities. Therefore, the personal assets of an S-Corporation's shareholders are generally protected from being used to satisfy the company's debts and liabilities. This is also true for members of LLCs and limited partners in LPs.
Disadvantages of S-Corporations
While the potential advantages of structuring a business as an S-Corporation are numerous, there are several limitations and potential drawbacks to consider, including, but not limited to the following:
-Unlike partnerships, LLCs and sole proprietorships, S-Corporations must observe all of the legal and administrative formalities of a corporation, such as holding annual meetings and maintaining minutes.
-Unlike C-Corporations, an S-Corporation can only issue one class of stock.
-Unlike C-Corporations, an S-Corporation may not have more than 100 shareholders.
-An S-Corporation's income is taxed to the shareholders whether or not such income is actually distributed to the shareholders.
-Only US citizens, resident aliens, and certain types of entities may hold stock in an S-Corporation.
-S-Corporations in California are required to pay a 1.5% state tax on net income.
Seek Legal Advice
When forming a new business, it is important to understand the pros and cons of each business entity in order to make an informed decision about which structure will best meet the specific needs of the business. This article provides an introduction to some of the considerations involved in creating an S-Corporation in California, but it is not a substitute for competent legal advice or tax advice. Entrepreneurs in California should consult with a knowledgeable business formation lawyer for a thorough discussion of the complex legal issues involved in choosing a business structure.
Article provided by Alliance Legal Partners, Inc.
Visit us at http://www.alliancelegalpartners.com