California Business Structures
Guide to Structuring Your Business in California
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.
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 an “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
- Corporation (S corporation or C corporation)
- Limited liability company (LLC)
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.
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.”
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.
A California corporation can be either a General Stock Corporation, a Close Corporation, a Professional Corporation, a Benefit Corporation, or a Social Purpose Corporation. The general stock is the most common, but a close corporation may be used for small businesses. Certain licensed professionals, including architects, lawyers, or medical professionals, are limited to forming a professional corporation (or an LLP). For info on Benefit Corporations and Social Purpose Corporations, see our Guide to Social Enterprise in California.
If you search for a corporation on the Business Search function of the California Secretary of State website, next to “Entity Type” you will commonly see either “Domestic Stock” or “Foreign Stock.” Domestic/Foreign refers to whether it is incorporated in California or not (see below). “Stock” means it’s simply one of the above forms of corporation, rather than a non profit corporation.
For tax purposes, the default is that a corporation is considered a “C Corporation,” but the corporation can also choose to be taxed as an “S corporation.” As a C Corporation, the corporation itself is taxed on its earnings, and then when the income of the corporation is passed to the owners of the corporation, the owners are taxed as individuals. This situation is known as “double taxation.”
What is a “foreign corporation”?
Foreign corporation means a corporation based outside of California. It does NOT necessarily mean international corporations, but generally refers to corporations established in other states, commonly Delaware or Nevada.
This is in contrast to a “domestic corporation” which is simply a corporation incorporated in California.
What is an “S corporation”?
An “S corp” or “S corporation” is simply a corporation that has filed paperwork to be taxed only through the owners, and not the entity itself. This avoids the “double taxation” of C corporations. This is often a way to save on taxes, but discuss with a tax professional for your particular situation. See more at our full Guide to S 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:
- 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 business?
Though it may seem confusing, it can generally be boiled down to 2 questions:
1. How much taxes will you pay under each structure? This will depend on your unique circumstances. With an LLC or corporation (probably S corp), you may be able to pay less in taxes (particularly self-employment taxes) than under a partnership or sole proprietorship. Or you may end up paying a bit more, but it could be worth it to secure asset protection (see #2, below). You should definitely talk to a qualified tax professional (such as an accountant) about this.
2. If your taxes will increase with an LLC or corporation, are you willing to pay extra in order to protect your personal assets from business debts and obligations? If your taxes will be the same or will decrease by forming an LLC or corporation, it’s pretty much a no-brainer to set up one of those structures. But even if your taxes will increase, 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. If you aren’t willing to pay more for this asset protection, you will probably want to stick with a sole proprietorship (if an individual) or a general partnership (if 2 or more business owners).
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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.