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Convert Sole Proprietorship to New Business Entity, but which one would should I pick?

Sacramento, CA |

I recently started an IT Services business in California as a sole proprietor but now am considering converting to either an S-Corp or LLC. I am aware that as an LLC, I can choose to get taxed as an S-Corp should I elect that option. I would be the sole owner of the new entity. I am aware of the different restrictions on stock owners as S-Corp and how the LLC is more flexible in those areas. I'm leaning toward LLC just for the simplicity but then I saw information about close corporations. So, here is where I am having problems picking entity type. Should I pick LLC, S-Corp, C-Corp, or a Close Corp (S or C)? The annual minimum tax seems the same between corp and LLC, $800 so this is why it's hard for me to pick. I'm almost certain the C-Corp options are not needed now but still unsure.

Attorney Answers 5


  1. Best answer

    The first question is whether doing business through an entity will be worth the expense and complication. A limited-liability entity will not protect you from claims based upon your personal negligence, so if you are doing all of the work yourself the entity may not provide the benefit you expect (though you may also have tax or other reasons to convert to a legal entity). Limited liability entities can provide some protection for owners against liability for what their co-owners or employees do, though this can also be covered somewhat through insurance.

    In 35 years of practice I have never known any attorney to set up a California statutory close corporation; that bit of legislation seems to have been a solution in search of a problem. For corporate law purposes, there is no difference between a Subchapter C and a Subchapter S corporation–it is only a tax election, available under defined circumstances. As between corporations and limited liability companies, LLCs are more flexible in defining the financial deal between co-owners and do not require annual minutes, but I find that my clients are often more familiar and comfortable with the concepts and terminology of corporations (and the annual requirements can be handled easily with a small amount of yearly attention). If you choose a corporation, remember to comply with the state and federal securities rules for the stock issuance; chances are that a simple California filing will suffice.

    I am not a tax attorney, but I am able to raise a few key issues which my clients can discuss with their tax advisors. These are the main tax questions I would ask: (1) Will California’s gross-revenue tax on limited liability corporations result in a higher state tax burden than with a Subchapter S corporation? (2) Will the business be generating losses which you want to write off against your personal income, if the requirements are met? (3) Will the company be reinvesting its income to a sufficient extent that the lower corporate income tax rate for a Subchapter C corporation (if it is indeed lower than your marginal personal rate) offsets the double tax on any dividends paid?

    This is an informal response based upon limited information and should not be relied upon by anyone. It is intended only to provide preliminary information on the subject, applying only California law. Legal counsel should be retained to provide specific advice based upon a full examination of the facts and relevant law. Robert Wm. Sloat will not act as someone's attorney until a formal retainer agreement has been signed. For more information please go to www.robertsloatlaw.com.


  2. I'm so old I remember why LLCs were created!!!
    It was because corporations and foreign residents could not be shareholders of a Sub-S.

    The maintenance of each is about equal. The cost is equal (i.e. $800 minimum Franchise Tax).

    Since you want to make a success of the business, I would get the input of my CPA, since, according to the old proverb "it's not what you make but what you keep". Maybe something in your personal profile makes one preferable.

    Other than that, almost no practical difference.

    The above is general legal and business analysis. It is not "legal advice" but analysis, and different lawyers may analyse this matter differently, especially if there are additional facts not reflected in the question. I am not your attorney until retained by a written retainer agreement signed by both of us. I am only licensed in California. See also avvo.com terms and conditions item 9, incorporated as if it was reprinted here.


  3. I agree with Mr. Doland. The differences between LLCs and any type of small corporation in terms of cost and complexity are minimal. Both are equally good at personal asset protection. Unless you plan on having more than 100 shareholders or having shareholders that aren't U.S. citizens, an S-Corp might work just fine for you.l

    Check with your CPA about any tax differences and then speak with a business attorney about your future plans for the business. After getting sounds tax advice, then make your decision.

    First, the firm is a debt relief agency according to the U.S. Bankruptcy Code. We help people file for bankruptcy. We also do other stuff and we do it well, but Congress wants me to post this notice. Second, nothing on this site is legal advice. You are not my client unless you enter into a written agreement signed by you and me.


  4. I would say you should sit down with an attorney and discuss the differences as well as the tax implications. You should also consult with a CPA in this regard. If you can find an attorney who is also a CPA that would be best. They will need to look at your cash flow and yearly income to give you good advice.


  5. When deciding between different entity types I believe the best advice is to really figure out what the clients business is, and what the client wants to achieve through forming the business.

    You recently started an IT Services business in California. This is a service that could generate a good amount of revenues and tax implications would obviously be important, but I would think that limiting liability would likely be critical. Specifically, I can see situations where your fees could run quite high and a breach of such fees could cause high risk.

    Now a cause of action for negligence is not limited by forming an entity, however a breach of contract (among other causes of action) can be. Now with that goal in mind, it is important to consider that formalities must be complied with in order to receive limitation of liability benefits. A California Corporate form has more stringent requirements than an LLC in your situation because you would have to keep corporate formalities/minutes, etc.

    I therefore would recommend, for your situation, to have less requirements to keep up with in order to receive the liability benefits and go with the LLC.

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