Forming Your Winning Business: A Guide to Choosing the Right Entity
Mark Smith • March 10, 2024
Starting a business in California? Choose the right legal structure: C Corp, S Corp, LLC, Sole Proprietorship, or Partnership. Expert tips on liability, taxes, & growth.
Choosing the ideal business structure is a cornerstone of your California venture's success. This decision has significant implications for growth, liability protection, and taxation. A crucial decision factor is the extent to which you wish to protect your personal assets against business liabilities. This blog post outlines the features and considerations of the most common business entities in California, empowering you to make the best choice for your business.
Top Entity Options for Your California Business
C Corporation: The Heavyweight - C Corporations offer limited liability and access to substantial capital, making them a popular choice, particularly for larger businesses seeking growth and shareholder investment. However, they come with double taxation and complex regulations. (C Corporations - https://www.ftb.ca.gov/file/business/types/corporations/c-corporations.html)
- Pros:
- Limited Liability: Shields shareholders from personal liability.
- Capital Generation: Ability to raise funds through stocks or bonds.
- Continued Existence: Operations aren't tied to specific owners or founders.
- Structured Governance: Guided by a board of directors and officers.
- Cons:
- Double Taxation: Profits taxed at the corporate level and again as shareholder dividends.
- Required Disclosures: Substantial information is publicly accessible.
- Complex Governance: Board structure, regulations, and formalities.
- Less Suitable for Small Ventures: Administrative burdens and costs may outweigh benefits for smaller entities.
S Corporation: The Middleweight - S Corporations strike a balance between liability protection and tax efficiency as they avoid federal double taxation, though California still applies corporate taxes at the state level. They also have strict eligibility requirements, limitations on the number of shareholders, and restrictions on the types of stock that can be issued. (IRS: https://www.irs.gov/businesses/small-businesses-self-employed/s-corporations; S Corporations - https://www.ftb.ca.gov/file/business/types/corporations/s-corporations.html)
- Pros:
- Limited Liability: Safeguards personal assets of shareholders.
- No Federal Double Taxation: Profits taxed only at the individual level
- Continued Existence: Operations continue despite ownership changes.
- Cons:
- Rigid Eligibility Criteria: Limited to 100 shareholders, one class of stock, etc.
- Formalities and Regulations: Compliance and rigorous documentation.
- Required Disclosures: Substantial information must be disclosed.
- Investment Restrictions: Limits ability to attract external investment.
- Less Attractive to Investors: Ownership restrictions may deter investors.
Limited Liability Company (LLC): The Adaptable All-Star - LLCs are a popular choice due to their flexibility in management and profit-sharing. They provide liability protection with pass-through taxation, albeit with higher fees in California. (California Revised Uniform Limited Liability Company Act: https://law.justia.com/codes/california/2022/code-corp/title-2-6/)
- Pros:
- Limited Liability: Provides liability protection like a C Corporation.
- Pass-Through Taxation: Avoids corporate double taxation (federally).
- Customizable Operating Agreement: Flexibility in ownership, management, profit-sharing.
- Cons:
- Certain Professions Restricted: Some fields (like law) may be ineligible.
- High Upkeep Fees: California requires significant maintenance fees.
- Investment Opportunities: Not as extensive as C Corporations.
General Partnership: The Team Playmaker - General Partnerships are formed by two or more individuals collaborating on a business venture. Partners share responsibilities, profits, and risks. (California General Partnerships - https://www.taxes.ca.gov/Income_Tax/genpartbus.html)
- Pros:
- Shared Responsibilities: Collaborate with partners in management and operations.
- Direct Taxation: Report business income on personal tax returns.
- Simplified Formation: Minimal formalities, often established through agreements.
- Collective Resources: Combine skills, expertise, and capital.
- Immediate Decision-Making: Avoids complex governance.
- Cons:
- Personal Liability: Partners are personally liable for business debts and actions.
- Shared Decision-Making: Joint decisions might lead to disagreements.
- Personal Disruptions: Partners' actions impact the business and create liability for others.
- Limited Investment Avenues: Difficulty attracting external investment.
Sole Proprietorship: The Solo Performer - Sole proprietorships offer the simplest structure and complete control, but the owner is personally liable for business debts. (California Sole Proprietorship - https://www.ftb.ca.gov/file/business/types/sole-proprietorship.html)
- Pros:
- Full Autonomy: Operate your business as a single individual with complete control.
- Direct Taxation: Report business income on personal tax returns; no corporate taxation.
- Simplified Formation: Minimal formalities; the business is an extension of the owner.
- Quick Decision-Making: While avoiding complex governance.
- Cons:
- Personal Liability: The owner is personally liable for business debts and actions.
- Lack of Separation: No legal distinction between the individual and the business.
- Limited Investment Avenues: Difficulty in attracting external investment.
- Limited Scale Potential: Growth may be constrained by individual capacity.
Choosing Your Champion: Key Questions
- Liability Protection: How important is it to shield your personal assets from business debts?
- Taxation: Is avoiding double taxation a key priority?
- Ownership: Will you have co-owners or operate the business solo?
- Growth: Do you anticipate major expansion or seeking external investment?
Expert Guidance - Consult with qualified legal and tax professionals for personalized advice on the best business structure for your California venture. The right choice sets the stage for long-term success.
Ready to start your business? Let's go!
Disclaimer: The information provided in this blog post is intended for general informational purposes only and does not constitute legal advice. It is essential to consult qualified legal and tax professionals for advice tailored to your specific business circumstances. Laws and regulations change. Always consult up-to-date sources like the California Franchise Tax Board (https://www.ftb.ca.gov/) and the California Secretary of State (https://www.sos.ca.gov/) for the latest information.
First Thing to Do and What You Can't Do Divorce is more than a personal and emotional shift; it is a legal and financial shift that will substantially impact your estate plan. Without proper action, your assets may end up in the wrong hands. Therefore, there are steps that you must take if you are in the process of a divorce or are already divorced. The first step is to review your prior estate plan after your divorce. If your divorce is still pending, you cannot change your current estate plan, except for a few exceptions. The rationale is that your spouse likely has an interest in the assets of your estate plan. Our legal system does not want spouses shielding their assets until the divorce is final. This is particularly true in California because California is a community property state, meaning thatall assets acquired during the marriage, other than outside bequests or inheritances, belong equally to the spouses. However, you can generally still revoke your Last Will and Testament, but you can only create a new one if you only devise your separate property and have half interest in the community property. You can create a new trust if you don't fund it until the divorce is final. Funding means to put assets inside the trust, usually by changing the title to the asset to the name of the trust. As you can see, there are many legal nuances here.
Purchasing a home or other property is among the most significant purchases a person can make. Real estate transactions are also complex and time-consuming. Therefore, it's critical you avoid the following real estate contract mistakes to ensure a smooth transaction: Failing to Disclose Known Defects Sellers are legally required to disclose any known material defects with the property. Disclosure is not optional. What I see as the most significant point of confusion is what is considered a material defect. So, what is a material defect? A material defect is an issue withthe property that could significantly impact the property's value or pose a danger to people. Even this definition may not be precise enough for some. Therefore, my advice would be to air on the side of disclosure. It's better than having the contract canceled or, worse, being sued later. Example: John is selling his home. John is aware that the basement of his house has a long history of flooding when it rains. John sells the home to Sally without disclosing the basement's history of flooding. Because the basement flooding is a material defect, Sally could recover damages from John for his failure to disclose.
How AI Works AI generates its responses through sorting through large quantities of data on the internet. This can include websites, novels, blogs, and sites like Facebook. This is a 1000-foot view of what AI does and is not meant to minimize the technology. However, understanding the basics is important to answer whether one should use AI to generate an estate plan. Why This matters? An estate plan is among the most personal legal endeavors a person will take. That’s because it is highly individualized and rarely are two estates the same. Clients have various intentions for how they want their estate to be distributed, often not based on what would seem logical, but instead on very personal beliefs. Clients also vary on how they want their estate handled if they are incapacitated for example, or how their pets are to be cared for, end-of-life decisions, and the list goes on and on. While an AI or software program can ask some of these questions, they will not read a client like an experienced attorney who will proactively investigate and inquire. For these reasons, AI often struggles with answering highly individualized questions. This is because AI thrives on generalizations since it gathers its data in the aggregate. This can be even more of a concern if the user is not savvy with AI. It’s often said in AI communities that an AI is only as good as the questions it's asked. AI Accuracy I’d bet most users vastly different testimony regarding AI accuracy. Some may point to different AI versions or programs having varying levels of accuracy. Based on my experience, the accuracy is often correlated with the subject matter. The more general question, the more precise. Legal nuisances, partly grey areas, are where I have noticed the most struggles with AI accuracy. Like most of you, I’d wager that AI will become more accurate with time. However, will it ever be accurate enough to bet your estate on? I say this because even if an AI is 99% accurate, it may be that 1% that makes the difference. Remember that AI owes you no legal duty whereas an attorney is accountable for their work.
What is Step Up in Basis and Why is it Important? The step-up in basis rule can dramatically reduce capital gains tax when an asset is sold after inheritance. Normally, an asset is calculated based on the original cost of the asset, not the current value. However, when an asset receives a step-up in basis when a person dies, that cost is readjusted based on its current market value, rather than the original cost. This can be critical since a piece of real estate that was bought, for example, in the 1990s, could save thousands if not millions, of dollars in tax on capital gains. Example Your parents bought a house for $100,000 ten years ago and the house is worth $500,000 when they die. Without a step-up in basis, if the house was sold there would be a capital gains tax on the $400,000, the house's appreciation. But with a proper strategy, when you inherit the house, the ‘basis’ (cost) is automatically ‘stepped’ up to the current value. If you then turn around and sell it for the same price, $500,000, you pay no capital gains tax. Holding Title and Step Up in Basis How a property's title is held might mean different tax results. These are the three common ways in which title can be held in California, joint tenancy, tenancy in common, and community property with the right of survivorship.
In today's digital age, we have more than just physical possessions to consider when planning for the future. Digital assets are electronic records that hold monetary value or sentimental importance, such as cryptocurrencies, online accounts, photos, videos, and documents. Additionally, these are assets that are acquired throughout one’s life and are often irreplaceable. Personally, I have acquired substantial digital assets throughout my life that are of great sentimental value to me, such as digital photos of my family. I’m sure most of you are in the same position. Here are some of the reasons why digital assets matter for estate planning: Digital currencies that operate independently of central authorities, like Cryptocurrency, may have significant monetary value. They are stored in digital wallets that require keys, passwords, or codes to access. Additionally, this should be included in your estate plans and provided to the executors or trustees with the necessary information to access them; otherwise, they may be lost forever or inaccessible to your heirs. Further, these are more difficult to track than standard currencies since they are not stored in a traditional bank like most currencies. It's best to make the management of digital currencies as easy as possible for your heirs. Digital assets are also vulnerable to data breaches, hacking, or theft. These types of breaches can become increasingly elaborate with technology and time. Therefore, without proper planning, you may lose access to valuable or sensitive digital assets, such as bank accounts, investments, or personal information. To prevent this, ensure secure storage and documentation of their digital assets and provide their executors with the means to access them. Moreover, they should also review the terms of service and privacy policies of the custodians of their digital assets, such as online platforms, cloud services, or apps, to understand their rights and obligations regarding their digital assets. Additionally, paid third-party assistance can also be used for assistance with breaches. I have personally experienced invasive breaches of digital assets and it’s a headache to deal with. Your heirs would appreciate not having to deal with these obstacles in a time of grieving. The Importance of digital photos cannot be understated. In our interconnected world, most of our cherished memories are captured digitally. This includes things like family photos, videos, and personal documents. You may want to preserve them for posterity, share them with loved ones, or even delete them for privacy reasons. Moreover, these photos can be on many platforms or cloud devices, such as Facebook or Google Drive for example. You should include them in your estate plans and provide the executors or trustees with the instructions and access to them. I personally have thousands of photos and I would be devastated if they were lost or inaccessible.
Understanding Proposition 19 Proposition 19 was enacted in California at the end of 2020 and created substantial obstacles for homeowners to avoid reassessment of their property. This is significant because, under Proposition 13, property taxes are limited to 2 percent annually absent a change in ownership. This can be a massive benefit, particularly in California, where it’s common for homeowners to have purchased their property at a time when home values were much lower, and therefore, so would their property taxes. However, absent an exception, if there is a change of ownership under Proposition 13 the property would be reassessed. In a nutshell, what Proposition 19 does is severely limit these exclusions. The current exclusions under Proposition 19 include victims of disasters, disabled persons, persons over 55 years of age, parent to child, and grandparent to grandchild.
Learn how to transfer your business into a trust with our comprehensive guide. Discover the benefits of avoiding probate, protecting your assets, and ensuring business continuity. Whether you have an LLC, general partnership, sole proprietorship, or corporation, we provide step-by-step instructions and highlight potential issues to consider. Maximize your estate planning strategy and secure your business's future. Consult with our expert attorneys for personalized advice on transferring your business into a trust.
Navigating estate planning for blended families can be complex and challenging. This comprehensive guide covers essential considerations, including guardianship decisions, fair asset division, and inheritance rights. Discover effective strategies like establishing trusts, making direct gifts, and ensuring open communication to protect your loved ones and minimize conflicts. Learn about the benefits and drawbacks of different trust structures, such as revocable trusts and A/B trusts, and how to leverage life insurance and separate accounts for smoother transitions. Consult with an estate planning attorney to create a customized plan that addresses your family's unique needs and ensures peace of mind.
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First Thing to Do and What You Can't Do Divorce is more than a personal and emotional shift; it is a legal and financial shift that will substantially impact your estate plan. Without proper action, your assets may end up in the wrong hands. Therefore, there are steps that you must take if you are in the process of a divorce or are already divorced. The first step is to review your prior estate plan after your divorce. If your divorce is still pending, you cannot change your current estate plan, except for a few exceptions. The rationale is that your spouse likely has an interest in the assets of your estate plan. Our legal system does not want spouses shielding their assets until the divorce is final. This is particularly true in California because California is a community property state, meaning thatall assets acquired during the marriage, other than outside bequests or inheritances, belong equally to the spouses. However, you can generally still revoke your Last Will and Testament, but you can only create a new one if you only devise your separate property and have half interest in the community property. You can create a new trust if you don't fund it until the divorce is final. Funding means to put assets inside the trust, usually by changing the title to the asset to the name of the trust. As you can see, there are many legal nuances here.
Purchasing a home or other property is among the most significant purchases a person can make. Real estate transactions are also complex and time-consuming. Therefore, it's critical you avoid the following real estate contract mistakes to ensure a smooth transaction: Failing to Disclose Known Defects Sellers are legally required to disclose any known material defects with the property. Disclosure is not optional. What I see as the most significant point of confusion is what is considered a material defect. So, what is a material defect? A material defect is an issue withthe property that could significantly impact the property's value or pose a danger to people. Even this definition may not be precise enough for some. Therefore, my advice would be to air on the side of disclosure. It's better than having the contract canceled or, worse, being sued later. Example: John is selling his home. John is aware that the basement of his house has a long history of flooding when it rains. John sells the home to Sally without disclosing the basement's history of flooding. Because the basement flooding is a material defect, Sally could recover damages from John for his failure to disclose.
How AI Works AI generates its responses through sorting through large quantities of data on the internet. This can include websites, novels, blogs, and sites like Facebook. This is a 1000-foot view of what AI does and is not meant to minimize the technology. However, understanding the basics is important to answer whether one should use AI to generate an estate plan. Why This matters? An estate plan is among the most personal legal endeavors a person will take. That’s because it is highly individualized and rarely are two estates the same. Clients have various intentions for how they want their estate to be distributed, often not based on what would seem logical, but instead on very personal beliefs. Clients also vary on how they want their estate handled if they are incapacitated for example, or how their pets are to be cared for, end-of-life decisions, and the list goes on and on. While an AI or software program can ask some of these questions, they will not read a client like an experienced attorney who will proactively investigate and inquire. For these reasons, AI often struggles with answering highly individualized questions. This is because AI thrives on generalizations since it gathers its data in the aggregate. This can be even more of a concern if the user is not savvy with AI. It’s often said in AI communities that an AI is only as good as the questions it's asked. AI Accuracy I’d bet most users vastly different testimony regarding AI accuracy. Some may point to different AI versions or programs having varying levels of accuracy. Based on my experience, the accuracy is often correlated with the subject matter. The more general question, the more precise. Legal nuisances, partly grey areas, are where I have noticed the most struggles with AI accuracy. Like most of you, I’d wager that AI will become more accurate with time. However, will it ever be accurate enough to bet your estate on? I say this because even if an AI is 99% accurate, it may be that 1% that makes the difference. Remember that AI owes you no legal duty whereas an attorney is accountable for their work.
What is Step Up in Basis and Why is it Important? The step-up in basis rule can dramatically reduce capital gains tax when an asset is sold after inheritance. Normally, an asset is calculated based on the original cost of the asset, not the current value. However, when an asset receives a step-up in basis when a person dies, that cost is readjusted based on its current market value, rather than the original cost. This can be critical since a piece of real estate that was bought, for example, in the 1990s, could save thousands if not millions, of dollars in tax on capital gains. Example Your parents bought a house for $100,000 ten years ago and the house is worth $500,000 when they die. Without a step-up in basis, if the house was sold there would be a capital gains tax on the $400,000, the house's appreciation. But with a proper strategy, when you inherit the house, the ‘basis’ (cost) is automatically ‘stepped’ up to the current value. If you then turn around and sell it for the same price, $500,000, you pay no capital gains tax. Holding Title and Step Up in Basis How a property's title is held might mean different tax results. These are the three common ways in which title can be held in California, joint tenancy, tenancy in common, and community property with the right of survivorship.
In today's digital age, we have more than just physical possessions to consider when planning for the future. Digital assets are electronic records that hold monetary value or sentimental importance, such as cryptocurrencies, online accounts, photos, videos, and documents. Additionally, these are assets that are acquired throughout one’s life and are often irreplaceable. Personally, I have acquired substantial digital assets throughout my life that are of great sentimental value to me, such as digital photos of my family. I’m sure most of you are in the same position. Here are some of the reasons why digital assets matter for estate planning: Digital currencies that operate independently of central authorities, like Cryptocurrency, may have significant monetary value. They are stored in digital wallets that require keys, passwords, or codes to access. Additionally, this should be included in your estate plans and provided to the executors or trustees with the necessary information to access them; otherwise, they may be lost forever or inaccessible to your heirs. Further, these are more difficult to track than standard currencies since they are not stored in a traditional bank like most currencies. It's best to make the management of digital currencies as easy as possible for your heirs. Digital assets are also vulnerable to data breaches, hacking, or theft. These types of breaches can become increasingly elaborate with technology and time. Therefore, without proper planning, you may lose access to valuable or sensitive digital assets, such as bank accounts, investments, or personal information. To prevent this, ensure secure storage and documentation of their digital assets and provide their executors with the means to access them. Moreover, they should also review the terms of service and privacy policies of the custodians of their digital assets, such as online platforms, cloud services, or apps, to understand their rights and obligations regarding their digital assets. Additionally, paid third-party assistance can also be used for assistance with breaches. I have personally experienced invasive breaches of digital assets and it’s a headache to deal with. Your heirs would appreciate not having to deal with these obstacles in a time of grieving. The Importance of digital photos cannot be understated. In our interconnected world, most of our cherished memories are captured digitally. This includes things like family photos, videos, and personal documents. You may want to preserve them for posterity, share them with loved ones, or even delete them for privacy reasons. Moreover, these photos can be on many platforms or cloud devices, such as Facebook or Google Drive for example. You should include them in your estate plans and provide the executors or trustees with the instructions and access to them. I personally have thousands of photos and I would be devastated if they were lost or inaccessible.
Understanding Proposition 19 Proposition 19 was enacted in California at the end of 2020 and created substantial obstacles for homeowners to avoid reassessment of their property. This is significant because, under Proposition 13, property taxes are limited to 2 percent annually absent a change in ownership. This can be a massive benefit, particularly in California, where it’s common for homeowners to have purchased their property at a time when home values were much lower, and therefore, so would their property taxes. However, absent an exception, if there is a change of ownership under Proposition 13 the property would be reassessed. In a nutshell, what Proposition 19 does is severely limit these exclusions. The current exclusions under Proposition 19 include victims of disasters, disabled persons, persons over 55 years of age, parent to child, and grandparent to grandchild.
Learn how to transfer your business into a trust with our comprehensive guide. Discover the benefits of avoiding probate, protecting your assets, and ensuring business continuity. Whether you have an LLC, general partnership, sole proprietorship, or corporation, we provide step-by-step instructions and highlight potential issues to consider. Maximize your estate planning strategy and secure your business's future. Consult with our expert attorneys for personalized advice on transferring your business into a trust.
Navigating estate planning for blended families can be complex and challenging. This comprehensive guide covers essential considerations, including guardianship decisions, fair asset division, and inheritance rights. Discover effective strategies like establishing trusts, making direct gifts, and ensuring open communication to protect your loved ones and minimize conflicts. Learn about the benefits and drawbacks of different trust structures, such as revocable trusts and A/B trusts, and how to leverage life insurance and separate accounts for smoother transitions. Consult with an estate planning attorney to create a customized plan that addresses your family's unique needs and ensures peace of mind.