One of the most difficult decisions an entrepreneur will need to make when starting a new business is just what kind of business entity they want to register as. While it sounds logical to register as a sole proprietorship if there are going to be no other members of the company, it doesn’t always best suit their purposes. Yes, sometimes doing business as a sole proprietor has its advantages.
However, before making that determination, it helps to know what other types of entities you can register as and the advantages of choosing one over the other. Here is a brief look at the types of businesses you can register in the State of California and then a look at why so many California corporations choose to register as an S corporation over a C corporation.
Classification of Business Entities in California
The first thing you need to look at is the various types of entities you ‘could’ register to do business as. The main categories are:
- Limited Liability Company (LLC)
- Limited Partnership (LP)
- General Partnership (GP)
- Limited Liability Partnership (LLP)
- Sole Proprietorship
All California corporations are automatically classified as C corporations unless you petition to be classified as an S corporation. However, there are certain qualifications your corporation must meet in order to be classified as an S Corp in California.
Taxes Are the Main Advantage
Both C and S corporations have shareholders who hold a stake in profits and losses. However, if your business meets the criteria for being classified as an S Corp, the Internal Revenue Service (IRS), states that S corporations “elect to pass corporate income, losses, deductions and credits” for tax purposes through to the corporation’s shareholders. You can find the criteria for being considered as an S corporation on the IRS website.
The Simplicity of an LLC
Another of the advantages of forming an S corporation is that this type of entity has the perfect blend of the simplicity of an LLC while having the complex advantages of a C corporation. While you would pay fewer taxes, the rules are much stricter. For example, an S corporation cannot have shareholders who are non-resident aliens, nor can they be other corporations. These restrictions are not found with C corporations. If you plan to allow big corporations to buy stock in your business, you will not qualify for S corporation filing status.
As you can see, the biggest advantages are found in how the government taxes and gives tax breaks to your S corporation. Small businesses typically prefer this type of filing for the simplicity of it, and of course, the tax breaks they wouldn’t get as a C corp. Even so, if you no longer meet the criteria for being an S corporation or plan to restructure your company opening up shares to a larger market, you can always change your filing status. There is nothing that says you are locked into the entity you registered as initially, and that is good to know.