Guide to Structuring Your Business in California

This page is part of our Guide to the Law for Entrepreneurs and Business Owners.

Sole proprietorships, partnerships, LLCs, S corporations, C corporations… the options for business structures might make your head spin! This page will discuss these structures as they apply in California. For a more thorough explanation of these concepts in general, see our Guide to Business Structures in the U.S.

Because your business structure can have major impacts on your financial and legal situation, it is very important to discuss with a lawyer and tax professional.

Get the new book for small business by Law Soup Media founder Tristan Blaine!

1. Structuring your business as a “non entity”

The basic idea is that if you start doing any business activity on your own in California, but you don’t form an “entity,” you are automatically a California sole proprietor aka sole proprietorship. If you start doing any business activity in California with one or more others, but you don’t form an entity, you are automatically a California general partnership. Both the sole proprietorship and general partnership are “non entities,” as they are not considered separate from the owners.

What is a California sole proprietorship?

A California sole proprietorship simply is the name given to a business that is operated in California by an individual person who has not formed a legal entity. Sometimes people refer to this situation as a DBA, but this is not quite accurate. A DBA is not a business structure, although many sole proprietorships need to obtain a DBA (however, many do NOT). See our Guide to California DBAs for more.

In this business form, your personal assets (such as house, car, etc) are subject to be taken if the business cannot meet its financial obligations.

What is a California general partnership?

A California general partnership is simply the designation of a business that is operated in California by more than one “person” (which can mean either a human or a legal entity), and which has not formed its own entity.

In this business form, the personal assets (such as house, car, etc) of each of the partners are subject to be taken if the business cannot meet its financial obligations.

Sometimes people refer to this situation as a DBA, but this is not quite accurate. A DBA is not a business structure, although many general partnerships need to obtain a DBA (however, many do NOT). See our Guide to California DBAs for more.

For tax purposes, the partnership itself is not taxed, but each owner is taxed individually in proportion to their share of the assets.

2. Structuring Your Business as an Entity

So what exactly is a business entity?

A business entity is generally distinguished from “non entities” of a sole proprietorship or general partnership. In California, a business can operate under various types of forms, depending on whether you are a solo owner or there are multiple owners. These are generally limited liability entities, meaning that they limit the liability of the owners so that only the business assets (not the owners’ personal assets) are to be used in case the business cannot meet its financial obligations. Once created, these have a “life of their own” and are a separate thing from the owners, though the owners control and carry out activities of the entity.

Here are the main forms of entities in California:

For solo owners

For multiple owners

  • Corporation (S corporation or C corporation)
  • Limited liability company (LLC)
  • Limited partnership (LP) – only the limited partners have limited liability, while the general partner does not have limited liability
  • Limited liability partnership (LLP) – only for certain professionals such as architects, lawyers, etc.

Non ownership

There is also an entity which has no owner, which is the California non profit public benefit corporation (not to be confused with the for profit benefit corporation). While not typically used for “business” purposes, it is an alternate form for certain operations in which the operators do not aim to make personal profit for themselves.

What is a California LLC?

LLC stands for Limited Liability Company. This is a proper business entity, created in California by filing Articles of Organization with the California Secretary of State. It is similar to a corporation, but (usually) somewhat simpler to form and operate, with (usually) less paperwork necessary.

An LLC is usually taxed the same as a partnership, however it can also choose to be taxed as an S corp or C corp.

See more about California LLCs.

What is a California corporation?

A corporation is a proper business entity, created in California by filing Articles of Incorporation with the California Secretary of State. Compared to an LLC, it is (usually) a bit more complex to form and operate with (usually) more paperwork required.

See more about California corporations.

Less common “informal” entities

There are a few more types of entities in California which are not quite as common, and are less formal than the others discussed above. These include:

  • Trusts
  • Unincorporated association
  • Unincorporated nonprofit association

A trust is often used as a “holding company” to passively manage assets, for either for-profit or charitable purposes.

An unincorporated association may be operated for either for-profit or charitable purposes, with fewer rules compared to an LLC or corporation.

An unincorporated nonprofit association may be operated only for charitable purposes, with fewer rules compared to a non profit corporation.

3. Choosing a Business Structure

Which business structure is best for my California business?

Though it may seem confusing, it can generally be boiled down to 2 questions:

1. Will you save on taxes by forming an entity? The answer to this question depends on your unique circumstances. Particularly with an S Corporation, you may be able to pay less in taxes than under a partnership or sole proprietorship. If so, it’s almost a no-brainer to form an entity. But definitely talk to a qualified tax professional (such as an accountant) about this.

2. How important to you is it to protect your personal assets from business debts and obligations? Even if you will not save money on taxes, you may still want to do either an LLC or corporation because under either of these structures you will be able to protect or shield your personal assets from the debts or obligations (including lawsuits) of the business. This is known as “limited liability.” See more, below.

The main drawbacks are costs and paperwork to set up and maintain the entity. In California, the costs are generally $100-$150 in government set up fees; and $800 per year in “annual minimum franchise tax” or 1.5% of net income, whichever is higher. So you need to decide if it’s worth it to you.

CHECK OUT OUR CHARTS!

We’ve created charts comparing the most important factors involved with the various types of entities: Check out the chart for solo business owners, and the one for two or more business owners.

What are the pros and cons to forming an entity?

In sum, here are the benefits and drawbacks of forming and maintaining an LLC or corporation in California.

Benefits:

  • Protects personal assets (limited liability)
  • Possibly save on taxes
  • Enhanced sense of legitimacy: Customers, clients, banks, landlords, and others tend to view you as a more serious business if you have an LLC or corporation
  • Don’t need to receive 1099s if you are a corporation

Drawbacks:

  • Costs: set up fees, annual fees
  • Paperwork
  • Small Claims Court claims are more limited: In California, corporations and LLCs can only sue for up to $5,000 in small claims; others including sole proprietorships and partnerships can sue for up to $10,000

Should I form my company out of state?

Maintaining a business entity in California costs at least $800 per year in fees, so many people wonder whether they can avoid the fees by forming out of state. The short answer is it’s not that easy. Basically if the owner(s) of an out of state (foreign) business live in California, the California business fees most likely will apply. And you will need to register a qualification to do business in California (aka Statement and Designation by Foreign Corporation), and generally file ongoing compliance in each state.

But if you have a “startup” and are planning to grow very quickly and get major investment, it may make sense to incorporate your business outside of California. In particular, many large businesses are formed in Delaware due to its more business friendly laws and taxes. But as always, talk to a tax professional for your situation.

4. Pass Through Taxes

What is “pass through” taxation or a pass-through entity?

Pass-through tax treatment simply means the business income is not taxed at the company level, but passes through to the owners of the business. Each owner is then taxed according to their share of the business.

The following by default have pass-through taxation: Sole proprietorships, partnerships, LLCs, S corporation.

See more about Business Taxes.

Further Resources

Much more detail on business structures can be found in our new book, Do it Like a Boss: What Every Small Business Owners Needs to Know About Law and Taxes

See our Guide to the Law for Entrepreneurs and Business Owners

If you have additional questions or need help with your business structure, discuss with a lawyer and tax professional.


Photo credit: Image by freepik

Author

  • Tristan Blaine

    Tristan Blaine is the founder of Law Soup Media, and has been a licensed attorney since 2013.

    About Tristan
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