Business 101
Choosing a Business Structure
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Start Your Business with the Right Foundation
The business structure you select can affect how your company is managed, how its income is taxed, how ownership is organized, and whether your personal assets may be exposed to business debts or claims.
Common structures include sole proprietorships, partnerships, limited liability companies, and corporations. Each has different formation requirements, costs, tax treatment, administrative responsibilities, and liability considerations.
Understanding these differences can help you make a more informed decision before preparing and filing your business documents.
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01
SOLE PROPRIETORSHIP
Small Family
Owned Business
-One Owner
-Self-employment tax
-Personal Tax
-Unlimited Personal Liability
Sole Proprietorship
A sole proprietorship is the simplest form of business ownership. It is owned and operated by one individual and generally does not require formation documents to be filed with the California Secretary of State. A person who begins conducting business without forming another type of business entity is generally operating as a sole proprietor.
A sole proprietorship is not legally separate from its owner. The owner receives the business profits, reports the business income on the owner’s tax return, and is personally responsible for the business’s debts, obligations, and liabilities. This means the owner’s personal assets may be at risk if the business is sued or cannot pay its debts.
If the business operates under a name other than the owner’s legal name, the owner may need to file a Fictitious Business Name Statement, commonly called a DBA, with the county where the principal place of business is located. Local business licenses, permits, tax registrations, and other filings may also be required.
A sole proprietorship may be appropriate for a small or relatively low-risk business, particularly when an owner wants to begin operating with minimal formation requirements or test a business concept before considering a more formal structure. However, because it does not provide liability protection and cannot issue ownership shares, it may be less suitable for businesses with significant risks, employees, substantial assets, outside investors, or major financing needs.
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Key Features
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One individual owns and controls the business.
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No separate legal entity is created.
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The owner is personally responsible for business debts and liabilities.
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Business profits and losses are generally reported on the owner’s individual tax return.
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A fictitious business name filing may be required.
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Business licenses, permits, and tax registrations may still be necessary.
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Raising money from investors may be more difficult because a sole proprietorship cannot issue stock or ownership interests.
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Important: Choosing a business structure can affect personal liability, taxes, financing, ownership rights, and future business operations. LDA Document Services cannot recommend which business structure is best for you. Consider consulting a licensed attorney, accountant, or tax adviser before making your selection.
02
PARTNERSHIP
-Two + owners
-Unlimited Personal liability, unless a limited partnership
-SE tax (except LP), Personal tax
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Partnership
A partnership is a business owned by two or more people who agree to carry on the business together. The partners may contribute money, property, labor, or expertise and share in the business’s profits, losses, management, and responsibilities.
California recognizes several types of partnerships. The principal forms are a general partnership, a limited partnership, and, for certain licensed professions, a limited liability partnership. Each structure has different filing requirements, management rules, tax treatment, and liability consequences.
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General Partnership
A general partnership may be created when two or more people operate a business together for profit, even if they do not formally register a separate business entity.
Unless the partners agree otherwise, each partner may participate in managing the business. General partners may also be personally responsible for partnership debts and obligations, including certain obligations arising from the conduct of another partner.
A written partnership agreement is strongly recommended. It can address:
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Each partner’s ownership interest
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Contributions of money, property, or services
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Management authority
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Allocation of profits and losses
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Voting and decision-making
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Admission or withdrawal of partners
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Dispute resolution
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Sale or dissolution of the business
Limited Partnership
A limited partnership, or LP, has at least one general partner and at least one limited partner.
The general partner generally manages and controls the business and may have personal liability for the partnership’s debts and obligations. A limited partner’s liability is generally limited, but the extent of that protection depends on applicable law, the partnership structure, and the partner’s conduct.
The partnership agreement should clearly describe:
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The authority and responsibilities of the general partner
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The rights of limited partners
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Capital contributions
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Allocation of profits and losses
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Distributions
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Voting rights
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Transfers of partnership interests
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Withdrawal, dissolution, and succession procedures
A California limited partnership must generally file formation documents with the California Secretary of State.
Limited Liability Partnership
A limited liability partnership, or LLP, is a partnership structure that may provide partners with protection from certain partnership obligations and from liability arising from another partner’s professional misconduct.
In California, LLPs are generally limited to specified licensed professions, including:
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Attorneys
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Certified public accountants
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Architects
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Engineers
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Land surveyors
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Certain related professional-service partnerships
An LLP is therefore not available to every type of business in California. A California LLP must register with the Secretary of State and comply with applicable professional licensing and insurance requirements.
Limited liability does not necessarily protect a partner from liability for the partner’s own wrongful acts, professional negligence, personal guarantees, or other obligations for which the partner is individually responsible.
Tax Treatment
Partnerships are generally treated as pass-through entities for federal and California income-tax purposes. The partnership typically files an informational tax return, while each partner reports the partner’s allocated share of income, deductions, credits, and losses on the partner’s own tax return, even when all profits are not distributed in cash.
Partners may also be responsible for self-employment tax and estimated tax payments, depending on their role, income, and the type of partnership interest. Tax treatment can vary, so partners should consult a qualified tax professional.
When a Partnership May Be Considered
A partnership may be considered when two or more owners want to operate a business together and share management, contributions, profits, and responsibilities.
Before choosing a partnership structure, the owners should carefully consider:
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Personal liability
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Management authority
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Tax treatment
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Capital contributions
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Profit and loss allocations
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Disagreements between partners
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Withdrawal or death of a partner
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Transfer of ownership interests
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Business continuity
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Whether another structure, such as an LLC or corporation, may better meet their needs
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03
LIMITED LIABILITY
COMPANY (LLC)
-1 or more owners
-Owners not personally liable
-Self-employment tax
-Personal/Corp tax
Limited Liability Company (LLC)
A limited liability company, commonly called an LLC, is a business entity that combines elements of a corporation and a partnership. The owners of an LLC are called members, and an LLC may have one or multiple members.
A California LLC is formed by filing Articles of Organization with the California Secretary of State. California also requires the LLC to maintain an operating agreement describing how the business will be owned and managed, although the operating agreement is not filed with the Secretary of State.
Limited Liability Protection
An LLC generally provides its members with protection from personal responsibility for the company’s debts and obligations. This means that a member’s personal assets, such as a home, vehicle, or personal savings, are ordinarily separate from the assets and liabilities of the LLC.
However, limited liability protection is not absolute. A member may still be personally responsible for:
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Personal guarantees
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The member’s own wrongful or negligent conduct
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Fraud or unlawful acts
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Certain taxes or employment obligations
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Improper mixing of personal and business finances
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Other circumstances in which liability protection does not apply
Maintaining separate business records, accounts, contracts, and finances is important.
Management and Ownership
A California LLC may be managed directly by its members or by one or more appointed managers. The operating agreement may address:
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Ownership percentages
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Initial contributions
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Management authority
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Voting rights
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Allocation of profits and losses
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Distributions
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Admission of new members
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Withdrawal, death, or incapacity of a member
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Transfers of ownership interests
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Buyout procedures
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Dissolution of the company
A well-prepared operating agreement can help establish continuity when membership changes. An LLC does not automatically need to dissolve every time a member leaves; the result depends on the operating agreement and applicable law.
Tax Treatment
An LLC does not have one automatic form of federal tax treatment. Depending on the number of members and any tax elections made, an LLC may be treated as:
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A disregarded entity owned by one person
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A partnership
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A C corporation
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An S corporation
A domestic LLC with two or more members is generally treated as a partnership for federal income-tax purposes unless it elects corporate taxation. A single-member LLC is generally treated as part of its owner’s tax return unless it elects another classification.
Members may be subject to income tax, self-employment tax, payroll tax, or other taxes depending on the LLC’s classification, the member’s role, and how compensation or profits are received. An LLC does not automatically produce a lower tax rate than a corporation or another business structure.
California LLCs are generally subject to an $800 annual tax while organized or doing business in California. An additional LLC fee may apply when California income exceeds $250,000.
Why Consider an LLC?
An LLC may be considered by business owners who want:
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Separation between business and personal liabilities
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Flexible ownership and management
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One or multiple owners
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Flexible federal tax-classification options
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A structure that can continue despite ownership changes
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Fewer corporate formalities than are commonly associated with a corporation
An LLC may be appropriate for some moderate- or higher-risk businesses, businesses with valuable assets, or owners who want liability protection. However, the cost, tax treatment, licensing requirements, annual California taxes, and administrative responsibilities should be considered before formation.
04
Corporation
C corp
Corporation
A corporation is a separate legal entity formed under state law. The owners of a corporation are called shareholders. Because the corporation exists separately from its shareholders, it can own property, enter into contracts, conduct business, incur debt, pay taxes, sue, and be sued in its own name.
A California corporation is generally formed by filing Articles of Incorporation with the California Secretary of State. Corporations must also comply with ongoing governance, recordkeeping, reporting, and tax requirements.
Liability Protection
A corporation generally protects its shareholders from personal responsibility for the corporation’s debts and obligations. Ordinarily, shareholders risk only the amount they invested in the corporation.
However, liability protection is not absolute. A shareholder, officer, or director may still be personally responsible for:
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Personal guarantees
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The person’s own wrongful or unlawful conduct
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Fraud or misrepresentation
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Certain unpaid payroll or employment taxes
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Improper distributions
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Failure to maintain adequate separation between personal and corporate affairs
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Other circumstances in which a court determines that personal liability is appropriate
Maintaining separate accounts, accurate records, proper corporate approvals, and required formalities helps preserve the corporation’s separate legal status.
Ownership and Management
Shareholders own the corporation by holding shares of stock. They generally elect a board of directors, which oversees major business decisions. The board appoints officers to manage the corporation’s daily operations.
Corporate records commonly include:
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Articles of Incorporation
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Bylaws
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Shareholder and director resolutions
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Meeting minutes
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Stock issuance and transfer records
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Financial and accounting records
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Statements of Information
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Tax filings
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Licenses and permits
Corporations usually require more formal administration than sole proprietorships, partnerships, and many LLCs.
Continuing Existence
A corporation generally continues to exist independently of changes in ownership. The death, withdrawal, or sale of shares by a shareholder ordinarily does not terminate the corporation.
This continuity may make it easier to:
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Transfer ownership interests
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Add new investors
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Establish succession plans
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Continue the business after an owner’s departure
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Sell the company in the future
Restrictions on stock transfers may still appear in the corporation’s governing documents or shareholder agreements.
Raising Capital
A corporation may raise capital by issuing stock, subject to applicable corporate and securities laws.
The ability to issue shares may help a corporation:
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Attract investors
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Raise money for expansion
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Provide equity compensation to employees
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Bring in additional owners
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Prepare for a future acquisition or public offering
Issuing stock involves legal, tax, accounting, valuation, and securities-law considerations.
C Corporation Tax Treatment
A corporation is generally taxed as a C corporation unless it qualifies for and makes an election to be taxed as an S corporation.
For federal income-tax purposes, a C corporation is a separate taxpayer. The corporation generally pays tax on its taxable income. If after-tax profits are later distributed to shareholders as dividends, the shareholders may also pay tax on those dividends. This is commonly referred to as double taxation.
Double taxation does not necessarily apply to every dollar earned by a corporation. For example, qualifying wages, benefits, and business expenses may be deductible by the corporation, subject to applicable tax rules.
California corporations are also subject to California filing and tax requirements. A corporation incorporated, registered, or doing business in California is generally subject to the state’s minimum franchise tax, although special first-year rules may apply.
S Corporation Election
An eligible corporation may elect to be taxed as an S corporation for federal tax purposes. An S corporation generally passes income, losses, deductions, and credits through to its shareholders, which may avoid the federal double taxation associated with a C corporation. Eligibility restrictions and additional tax rules apply.
An S corporation is a tax classification, not a different type of California legal entity. A corporation must first be properly formed and then make the appropriate tax election.
Why Consider a Corporation?
A corporation may be considered when the owners want:
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Separation between personal and business liabilities
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A business that can continue despite ownership changes
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The ability to issue stock
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Access to outside investors
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A formal management structure
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Equity compensation for employees
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A structure suitable for significant growth
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The possibility of a future sale or public offering
A corporation may also be appropriate when investors or lenders prefer a traditional corporate structure.
The added benefits come with additional responsibilities, including formation expenses, annual filings, corporate records, tax returns, meetings or written consents, and compliance with corporate formalities.
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05
Corporation
S Election
Electing S Corporation Tax Treatment
An S corporation is a federal tax classification, not a separate type of California business entity. An eligible corporation or limited liability company may elect to be taxed under Subchapter S of the Internal Revenue Code by filing IRS Form 2553, Election by a Small Business Corporation.
A business should generally be properly formed and have an Employer Identification Number before submitting the election.
Corporations
A corporation is generally taxed as a C corporation unless it makes a valid S corporation election.
When the election is accepted, the corporation generally becomes a pass-through entity for federal income-tax purposes. Its income, losses, deductions, and credits pass through to the shareholders, who report their respective shares on their personal tax returns.
This treatment may reduce or avoid the federal double taxation that can apply when a C corporation pays tax on its income and later distributes after-tax profits to shareholders as dividends. However, an S corporation may still owe federal tax in certain situations, including tax on specified built-in gains or excess passive investment income.
Limited Liability Companies
An LLC may also elect to be taxed as an S corporation without changing its legal form under California law.
The business remains an LLC for state-law purposes, including ownership, management, and liability matters, but it is treated as an S corporation for federal and California tax-reporting purposes.
An eligible LLC may generally make the S election directly by filing Form 2553. It ordinarily does not need to file Form 8832 first because a timely Form 2553 also serves as the election for the LLC to be classified as a corporation for federal tax purposes.
Eligibility Requirements
To qualify for S corporation treatment, a business generally must:
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Be a domestic corporation or eligible domestic entity
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Have no more than 100 shareholders or members
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Have only allowable owners
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Have no more than one class of stock or equivalent ownership interests
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Obtain the consent of all required shareholders or members
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Not be an ineligible type of corporation
Allowable owners generally include individuals who are United States citizens or residents, certain trusts, estates, and specified tax-exempt organizations.
Partnerships, most corporations, and nonresident aliens generally cannot be S corporation shareholders.
Filing Form 2553
The election is made by submitting IRS Form 2553. All shareholders or members whose consent is required must sign or otherwise properly consent to the election.
The form generally must be filed:
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No later than 2 months and 15 days after the beginning of the tax year for which the election is intended to take effect; or
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At any time during the preceding tax year
For a calendar-year business that existed on January 1 and wants the election effective that year, the filing deadline is generally March 15. A newly formed business may have a different deadline based on the date its first tax year began.
The IRS will ordinarily send written confirmation stating whether the election was accepted and its effective date. The business should retain that confirmation with its permanent records.
Late S Corporation Election
A business that misses the filing deadline may qualify for late-election relief.
Eligibility generally requires that:
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The business intended to be treated as an S corporation
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It otherwise qualified for the election
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The late filing was the only reason the election was ineffective
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There was reasonable cause for filing late
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The business and its owners reported consistently with the intended S corporation treatment
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The request is made within the applicable relief period
Many qualifying late elections may be corrected under IRS Revenue Procedure 2013-30. Relief is not automatic, and additional procedures may apply when the ordinary requirements are not met.
California Treatment
California generally follows a valid federal S corporation election. A separate California S election is ordinarily not required; the federal election generally becomes effective for California on the same date.
A California S corporation, including an LLC taxed as an S corporation, generally must:
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File California Form 100S
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Maintain separate business records and accounts
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Provide applicable Schedules K-1 to its owners
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Pay California tax on its net income at the applicable S corporation rate
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Pay the applicable California minimum franchise tax, subject to available first-year or other exceptions
California currently imposes a 1.5% tax on an S corporation’s California net income, in addition to the income passed through to shareholders. California S corporations are also generally subject to the $800 minimum franchise tax, although the minimum tax may be waived for a newly formed or qualified S corporation’s first taxable year.
Payroll and Reasonable Compensation
An owner who performs services for an S corporation may be treated as an employee and may need to receive reasonable compensation through payroll before receiving non-wage distributions.
The appropriate salary depends on the services performed, time devoted to the business, experience, responsibilities, industry compensation, and other facts. An S election does not allow an owner to avoid payroll taxes by characterizing all compensation as distributions.
Payroll and reasonable-compensation decisions should be reviewed with a qualified accountant or tax professional.
Potential Benefits
An S corporation election may offer:
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Pass-through federal income-tax treatment
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Possible avoidance of C corporation double taxation
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Potential payroll-tax planning for qualifying owner-employees
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Continued limited-liability protection through the underlying corporation or LLC
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A formal framework for paying wages and distributing profits
Important Limitations
An S election may also involve:
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Strict ownership eligibility rules
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A 100-owner limit
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Restrictions on classes of ownership
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Payroll and employment-tax obligations
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Separate federal and California tax returns
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Required bookkeeping and corporate records
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Pro rata allocation of income and losses
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Potential tax even when profits are not distributed
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Possible termination of the election if eligibility rules are violated
An S corporation election does not automatically reduce taxes, and it is not appropriate for every corporation or LLC.
Filing Assistance
LDA Document Services may prepare IRS Form 2553 at the client’s specific direction using information and decisions supplied by the client.
The client is responsible for:
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Determining whether the business qualifies
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Selecting the intended effective date
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Obtaining all required owner consents
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Confirming the tax year
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Filing the election by the applicable deadline
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Maintaining proof of filing and IRS acceptance
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Obtaining tax advice concerning compensation, distributions, payroll, and tax consequences
06
Professional
Corporation
(PC)
Professional Corporation
A professional corporation is a corporation formed to provide services that may lawfully be performed only by individuals holding a particular professional license, certification, or registration.
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In California, professional corporations are governed by the Moscone-Knox Professional Corporation Act, together with the statutes and regulations governing the particular profession. A professional corporation generally provides services within one licensed profession, except where California law expressly permits specified related professionals to participate.
Examples of professions that may operate through a California professional corporation include:
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Physicians and certain other health care professionals
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Attorneys
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Accountants
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Psychologists
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Marriage and family therapists
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Clinical social workers
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Professional clinical counselors
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Chiropractors
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Architects
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Veterinarians
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Other professions specifically authorized by California law
Not every licensed occupation is permitted to form a professional corporation, and each profession may have different ownership, naming, registration, insurance, and governance requirements.
Ownership Restrictions
Professional corporations are subject to stricter ownership rules than ordinary corporations.
Shares generally may be owned only by persons who are properly licensed to provide the professional services offered by the corporation, although California law permits certain combinations of related licensed professionals in limited circumstances. Transfers that violate the statutory ownership restrictions may be void.
Because ownership rules vary by profession, a person should not assume that:
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Any licensed professional may own shares;
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A spouse, family member, investor, or employee may become a shareholder;
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Another business entity may own the professional corporation; or
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A holding company may own the shares.
The statement that a holding company can never own shares is too broad. The more accurate rule is that ownership must comply with the specific statute and licensing-board rules governing the profession. For example, California law generally restricts transfers of professional-corporation shares to qualified licensed persons, existing shareholders, or qualifying professional corporations.
Articles of Incorporation
A California professional corporation is generally formed by filing Articles of Incorporation with the California Secretary of State.
The Articles must include language showing that the corporation is intended to operate as a professional corporation. California law also requires an appropriate statement describing the profession the corporation will practice. A typical purpose statement identifies the specific licensed profession and may include other lawful activities that are not prohibited for a corporation practicing that profession.
For example:
The purpose of the corporation is to engage in the profession of psychology and any other lawful activities not prohibited to a professional corporation engaged in that profession.
The exact language should be selected based on the profession and current filing requirements.
Corporate Name
The corporation’s name must comply with both:
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California Secretary of State naming rules; and
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Any additional rules imposed by the profession’s licensing agency.
The name must be distinguishable from other registered entities and must not be misleading. Terms such as Professional Corporation, P.C., or PC should not be used by an entity that is not actually organized as a professional corporation.
Permitted or required endings vary by profession. Depending on the applicable rules, a name may use terms such as:
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Professional Corporation
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A Professional Corporation
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P.C.
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PC
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Corporation
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Incorporated
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Inc.
The name should not be filed until the requirements of the governing licensing board have been reviewed. For example, California law corporations must register with the State Bar, and their names must include an approved corporate designation.
Licensing-Board Registration and Approval
Filing Articles of Incorporation with the Secretary of State may not be enough to authorize the corporation to provide professional services.
Depending on the profession, the corporation may also need to:
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Register with the applicable licensing board;
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Obtain a certificate of registration;
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Submit copies of professional licenses;
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Identify shareholders, directors, officers, and professional employees;
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Provide proof of insurance or other financial security;
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Obtain approval of the corporate name;
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File annual renewals or reports; and
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Comply with profession-specific bylaws and share-transfer restrictions.
For example, a California law corporation must be registered with the State Bar and maintain its authorization through required renewals. Accountancy corporations must provide information requested by the California Board of Accountancy and demonstrate that their ownership and professional personnel comply with licensing requirements.
Directors, Officers, and Shareholders
California professional corporations often require directors, officers, and shareholders to be licensed in the profession practiced by the corporation, subject to limited statutory exceptions.
The governing rules may also address:
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Who may serve as president, secretary, treasurer, or director;
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Whether one person may hold multiple offices;
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Who may vote shares;
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What happens when a shareholder dies, retires, loses a license, or becomes disqualified;
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How shares must be transferred or repurchased; and
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Whether related licensed professionals may hold a minority interest.
These rules differ significantly by profession.
Liability Protection
A professional corporation may provide shareholders with protection from certain business debts and contractual liabilities.
However, forming a professional corporation generally does not protect a licensed professional from personal responsibility for that professional’s own negligence, malpractice, wrongful conduct, or licensing violations.
A shareholder may also remain personally liable for:
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Personal guarantees
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The shareholder’s own professional services
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Fraud or unlawful conduct
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Certain tax or employment obligations
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Improper distributions
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Failure to maintain appropriate corporate separation
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Other obligations for which personal liability applies
Professional liability insurance may still be required or advisable.
Tax Treatment
A professional corporation is generally taxed as a C corporation unless it qualifies for and makes an S corporation election.
Tax treatment may affect:
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Corporate income taxes
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Shareholder compensation
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Payroll taxes
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Dividends
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Retirement plans
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Fringe benefits
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Estimated taxes
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California franchise taxes
A professional corporation does not automatically produce tax savings. A qualified accountant or tax adviser should evaluate the available tax elections and compensation structure.
Typical Formation Process
The process may include:
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Confirm that the profession is authorized to operate through a professional corporation.
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Review the rules of the applicable licensing board.
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Select a compliant corporate name.
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Prepare and file the Articles of Incorporation.
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Obtain an Employer Identification Number.
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Prepare profession-specific bylaws and organizational resolutions.
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Issue shares only to qualified persons.
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Appoint appropriate directors and officers.
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File the initial Statement of Information.
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Register with the applicable licensing board.
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Obtain required insurance, security, permits, and tax registrations.
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Maintain corporate and professional records.
The sequence may differ depending on the profession.
Why Consider a Professional Corporation?
A professional corporation may be considered when licensed professionals want:
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A formal business entity for their practice
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Continuity despite changes in ownership
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A defined management and ownership structure
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Separation of certain business obligations from personal affairs
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The ability to add qualified licensed shareholders
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Corporate tax-election options
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A structure required or recognized by their licensing board
The additional benefits come with specialized licensing, ownership, naming, recordkeeping, insurance, and governance requirements.