Sole Proprietorship

Forming A Corporation As a comparison. a sole proprietorship is set up to allow an individual to own and operate a business. A sole proprietor has total control, receives all profits from and is responsible for taxes and liabilities of the business. If a sole proprietorship is formed with a name other than the individual’s name (example: John Smiths Fishing Shop), a Fictitious Business Name Statement must be filed with the  county  where the principal place of business is located.

No formation documents are filed with the California Secretary of State’s office. Other state filings may be required depending on the type of business.

Limited Liability Company (LLC)

A California LLC generally offers liability protection similar to that of a corporation but is taxed differently. Domestic LLCs may be managed by one or more managers or one or more members. In addition to filing the applicable documents with the Secretary of State, an operating agreement among the members as to the affairs of the LLC and the conduct of its business is required. The LLC does not file the operating agreement with the Secretary of State but maintains it at the office where the LLC’s records are kept.

To form an LLC in California,  Articles of Organization  (Form LLC–1) must be filed with the California Secretary of State’s office.

Corporation

A California corporation  generally is a legal entity which exists separately from its owners. While normally limiting the owners from personal liability, taxes are levied on the corporation as well as on the shareholders. The sale of stocks or bonds can generate additional capital and the longevity of the corporation can continue past the death of the owners. Legal Counsel should be consulted regarding the variety of options available.

A corporation is a separate legal entity existing under authority granted by state law. It has its own identity, separate and apart from its shareholders. As such, all income of the corporation is taxed at the corporate income tax rate. Subsequently, if company profits are distributed to shareholders in the form of dividends, they are again taxed at the receiving shareholder's individual income tax rate. Hence the term "double taxation."

Corporations are formed, among other things, to shield shareholders from personal liability  for the corporation's activities. Creditors may look to the assets of the corporation for payment, but may not look to the shareholders' personal assets for payment.

However, the corporation must act like a corporation in order to qualify for the legal protection and tax advantages the corporate form offers. Unless all corporate formalities and requirements are adhered to (e.g., holding of shareholder and board of director meetings), the shareholders may be held personally liable for the corporation's debts and liabilities under the "alter ego" theory of liability (i.e., the corporate veil may be "pierced").

To form a corporation in California,  Articles of Incorporation  must be filed with the California Secretary of State’s office.

 

Comparison of the "C" and "S" Corporation 

"C" and "S" corporations are two particular forms of corporations that are prevalent in California. Both "C" corporations and "S" corporations are entities having the advantages of corporate form. Both enjoy centralized management and control through a board of directors elected by shareholders, privacy and anonymity of shareholder identities, as well as insulation of shareholders from personal liability.

The primary difference between "C" and "S" corporations involves income tax treatment. For income tax purposes, the "S" corporation is analogous to a sole proprietorship or partnership, and consequently, each item of income and expense is "passed through" directly to shareholders and not taxed at all at the corporate level. This allows owners of companies to take advantage of the corporate form and accompanying limited personal liability, but does not subject them to the double-taxation of corporate profits. As you can see, the "S" corporation is an attractive device for those business owners who want to distribute the majority of the corporation's net profits. However, because the tax rate for individuals with large incomes is generally greater than the highest corporate tax rate, shareholders of a corporation with extremely high profits could pay more to operate in an "S" form than in a "C" form.

 


By Attorney Stan Prowse
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