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.
