When starting a business in California, one of the most important decisions you’ll make involves choosing the best legal structure for your particular enterprise. You’ll want to keep business taxation concerns in the forefront of your mind as you make this decision.
The entity type that you choose won’t just affect how your business operates; it will also impact how much you’ll pay in taxes, how profits will be distributed and how you’ll manage compliance obligations at both the state and federal levels. It will also impact how you’re taxed and when.
Making a decision
The most common business structures include sole proprietorships, partnerships, limited liability companies (LLCs), S corporations and C corporations. Each is associated with distinct tax implications. For example, sole proprietorships and partnerships are considered “pass-through” entities, meaning that business income is reported on the owner’s/owners’ personal tax return(s). These structures avoid double taxation but may not provide the liability protection or flexibility that growing businesses need.
LLCs are popular in California for their simplicity and liability protection, but they are subject to the state’s annual franchise tax and an additional LLC fee based on total income. However, LLCs can elect to be taxed as an S corporation, which can offer self-employment tax advantages. It’s important to weigh the benefits of potential tax savings against increased administrative requirements and payroll obligations.
S corporations, which are also pass-through entities, allow business owners to take a reasonable salary while distributing the remaining profits as dividends, which may not be subject to self-employment tax. However, strict eligibility requirements—such as a limit on the number and type of shareholders—mean this option isn’t right for everyone.
C corporations are taxed separately from their owners, which can lead to double taxation (once at the corporate level and again when profits are distributed as dividends). However, C corps may offer advantages like easier access to capital, broader shareholder options and favorable tax treatment on retained earnings in some cases.
Forming a business with taxation in mind isn’t just about saving money—it’s about building a foundation that supports growth and long-term success.
