Choosing a California Business Structure

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Choosing a California Business Structure
 
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Comparing California Business Entities


California Corporate Taxations Issues When Choosing A Business Legal Structure

When choosing a business structure, business tax  issues are probably the main reason that most small business owners incorporate. You should consult with a accountant and or a tax attorney to discuss what is the best business structure for your particular tax situation.   There other issues such as civil liability for business actions as well but it is not covered in this article.

If you are an individual starting a business, you are called a sole owner unless you choose another business structure. If you operate a small business under a name different from your own personal legal name, you will be required to file a Doing Business As (DBA) certifate.  A DBA informs the public who exactly is doing business under the dba business name. DBA is not an official corporate business structure.   But note even corporations that do business under any name other than the full legal name of the corporation, they are usually required to file a DBA form certificate as well as the corporate certificate.  For example, the corporation name is XYZ, Inc, and the corproration is doing business as Nationwide Painting Contractors.  The XYZ corporation is required to file a DBA.

Keep in mind that you are solely liable for all your business related liability if you are a  sole owner.  In addition, if you are a general partnership, you are liable for your partners business liabilities as well as your own.  With that in mind, consider that choosing a favorable business structure may help you avoid all these liabilities.  The business structure to choose is A Califonria (CA) corporation or a Limited Liability Company.

In general, it is not recommended to do business as a sole proprietor, especially if you have employees.  Your employees may sue you for various reasons and you will be liable if you just file a dba.  A Califonria (CA) corporation is a more wise choice for business structure for most enterprises and small businesses starting a business. A Califonria (CA) corporation or LLC Limited Liability Company will shield your personal assets from most lawsuits or claims which could be brought against yourself and your business. Even if you are just one person and the sole proprietor owning any type of a business, you usually can incorporate or form an LLC anywhere your business is located.

When you incorporate or corporations are C-corporations, then  you can elect to be an S-corporation.   S-corporations are like C-corporations, except they have some additional legal requirements, such as limited number of shareholders and limiting who may be a shareholder. LLCs allow for foreigners to be members, but if you are a natural person (as opposed to a legal person, such as A Califonria (CA) corporation) and a U.S. Citizen, you can be a shareholder for an S-corporation.

There difference in S-corporations and C-corporations is in the way each corporate entity is taxed.  For example, S-corporations allow small business owners the civil and debt liability protection of incorporation as well as allow the shareholders to do their corporate taxes as individuals using a social security number .


Corporate Taxation

All corporations, including an LLC, an S-corporation or a C-corporation, (you can file one even if you are one person) it is a separate taxable entity.  Your C-corporation must pay taxes on any income that the C-corporation has at any given taxable year.

For example, let's assume that you pay a 25% federal corporate income tax rate  and your corporation had $100,000 profit for the taxable year in question.   After taxes, the corporation is left with $75,000 retained earnings.  You can leave this earnings in your corporate bank account (retain the earnings) or pay out yourself as dividends to the shareholder.  Note that you can also pay a reasonable salary for running the corporation or providing any other type of service for the corporation.   However, your salary is tax deductible to the corporation and taxable to you as personal income.

Now let's assume, you pay yourself, as a shareholder, $75,000 in dividends out of the retain earnings.  That's when double taxation occurs.   You must pay personal income tax on these dividends as well as corporate tax (i.e., the corporation paid already $25,000 tax on these corporate earnings).    The corporation paid 25% taxes plus your rate (about 30 %) you end up paying 45% effective tax rate.   Note that the above does not include state taxes.  Some states will additionally charge you for your personal tax (in California it is about 8% ) plus another possibly  8% tax for your corporation.  That would be about 60% tax rate. 

If you had elected to be an S-corporation, you would have to pay only your personal federal and state tax rate.  For example, let's assume that you pay a 30% personal federal income tax rate  and your corporation had $100,000 profit for the taxable year.  You would have to pay an one time $30,000.  Also, let's assume that in your state, you pay a 8% personal income tax rate  and your corporation had $100,000 profit for the taxable year.  You would have to pay that as well.  In both cases you pay as an individual and you don't have to pay anything else whether or not you have any retains earnings or not.

The strategy to defeat double taxation is to have a policy of not paying dividends to shareholders if you have a C-corporation.   If you do want to pay out your retain corporate earnings as dividends, it may be better to form an S-corporation.


 

 

 

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