Starting a Business and Selecting an Entity in San Diego
What’s the difference between an LLC, an S-Corporation and a C-Corporation? Why shouldn’t we just go with an LLC, download some forms and get to work? The choice of your business entity is a lot more than just forming some company so that you can go make money. The primary purpose of your business entity is to provide protections for you, your home, your spouse and your personal assets. A business entity is a shield – it is in place to allow you to separate your personal property and bank accounts from your new business. If you are in business, sooner or later liabilities will arise. They can come out of something as simple as a periodic cash flow challenge, or something as substantial as an employee dispute or a lawsuit brought by a customer or vendor.
But which entity should you select? What are the advantages and disadvantages of each form of entity? There is not enough room here to thoroughly cover these questions, nor is it possible to apply the law to your unique business circumstances. However, it is good for you to begin to think about how you will be conducting business and how it will grow, so that you are better prepared to have conversations with our experienced business attorneys and ultimately select a corporate structure that fits your business model.
LLCs and S-Corporations
Limited Liability Corporations (LLCs) and S-Corporations (or “S-Corps) are both entities that shield your personal assets from business creditors. The LLC is a “pass-through” entity, meaning all income and expenses are reported directly on your personal income tax forms. LLCs and S-Corps should allow you to deduct many expenses pre-tax including uniforms, health care, car expenses and telephone/technology expenditures. In an S-Corp, the owners may pay themselves a salary, but can also pay themselves “dividends” from any remaining profits. An LLC also does not have to file a separate tax return for the LLC itself, however, the owner(s) will have to pay the high “self-employment tax”.
The S-Corp allows you to pay owners a “reasonable” salary, but additional profits are distributed as “dividends” and these are taxed at a lower rate than standard income. S-Corps must be owned by a US citizen, and there are some tax ramifications to keep in mind. There are also some regulations on how profits and losses are to be allocated among the shareholders. If a shareholder owns 33% of the company they must receive 33% of the dividends (or profits and losses).
A C-Corporation (or C-Corp) is the most common type of corporation, and provides the greatest potential flexibility downstream, and allows for maximum growth. The S-Corp is limited to 1,000 shareholders, where a C-Corp can grow to become a multi-national entity with hundreds of thousands of stock holders. It all depends on what you intend for your company to become down the road, and what your exit strategy for the business will be. C-Corps are much easier to sell, transfer or otherwise transact. It may be easier to attract and raise future operating capital through public offerings (not available for S-Corps or LLCs). If you expect to generate substantial income, the C-Corp provides the ability to designate a fiscal year that is different from the calendar year. This allows high income earners to “defer” compensation into the following “tax” (read: calendar) year. C-Corporations are vulnerable to “double taxation” as taxes are paid on personal income that is disbursed to you, as well as a corporate tax on any remaining balance at the end of the corporate fiscal year.
Contact Experienced San Diego Entity Selection Lawyers
There are many other details that will ultimately drive your selection of a business entity as you begin your new San Diego business. Call the Watkins Firm today for a free consultation at 858-535-1511 or contact us to schedule an in-person consultation. We understand the importance of keeping costs down during the start-up phase of your business. We also understand that you are about to pour your time, money, and personal sweat into your new business. We want to help you to protect all of that effort and money, as well as your personal assets and home.