Attorney
One of the most important decisions that a California business owner can make is which legal form it should take. From sole proprietorships to corporations, there are various entities to choose from. The choice you make will have an impact on your and your organization’s taxes.
Knowing the tax consequences of the different business structures can help you better plan for:
- long-term success,
- limit your tax liability,
- and maximize your profits.
Let the dedicated legal team of Schneiders & Associates guide you.
C and S Corporations
There are two types of corporations from which you may choose: C and S. The traditional C corporation (or C corp) offers substantial protections from personal liability and enhanced credibility through management by a board of directors. As for taxes, although the business can take what are often substantial deductions, it is subject to double taxation: first the corporation itself pays taxes, then the owners pay taxes on their incomes and dividends.
The S corporation, or S corp, is not subject to this double taxation because the business itself is not taxed. Instead, profits pass through the legal entity and to its owners who pay their own income taxes. The tax filing rules for both C and S corps are generally more complicated versus other business forms.
Limited Liability Company
Also known as LLCs, these businesses are owned by their members and enjoy the liability protection of a corporation. If so elected, profits can pass through to members in much the same way they do in the S corp. The LLC does not pay a federal income tax but its members do pay taxes on what they take home.
However, the LLC must pay a minimum California tax (which is currently $800) regardless of whether it earned money. You should also know that if you are actively involved in running the LLC, you will have to pay a self-employment tax. This is a major difference between the LLC and the S corp.
Partnerships
California recognizes three different types of partnerships: limited liability partnerships, limited partnerships, and general partnerships. The respective tax advantages of each form are discussed below:
- Limited liability partnerships (LLPs): Profits pass through to the partners, based on their ownership interests in the LLP. Individual partners pay taxes on their incomes or shares of the LLP’s income, but the LLP itself is not taxed at the federal level. California LLPs must usually pay the minimum state tax that LLCs must pay.
- Limited partnerships (LPs): Profits also pass through to individual partners as per the LLP. The same self-employment tax that applies to certain LLC members (mentioned above) applies to certain LP partners as well.
- General partnerships (GPs): Profits pass through to members who pay their own taxes, but the GP itself is not taxed under federal or state law. There is a self-employment tax for certain partners, as mentioned above for the LP.
Sole Proprietorship
Since there is no legal distinction between a sole proprietor and their business, profits simply belong to the sole proprietor. This individual then files an income tax return to pay state and federal taxes. The sole proprietor also pays the self-employment tax.
Which Entity Is Right For You? We Can Help You Decide
Besides taxes, there are other considerations in deciding which business form is right for you and your organization. The entity that you select will be relevant to questions of liability, business formalities, future growth, and more. Contact Schneiders & Associates today to discuss these matters along with tax issues.
FAQs
What are the three different tax structures and what do they do?
Tax structures determine how the IRS and the State of California collect revenue from your work. They generally fall into these three categories:
- Direct Taxation: Used by Sole Proprietorships. Business income is reported directly on your personal tax return.
- Pass-Through Taxation: Used by S Corps, LLCs, and Partnerships. The business itself does not pay federal income tax. Instead, profits “pass through” to the owners, who report it on their individual returns.
- Double Taxation: Primarily affects C Corporations. The company pays a corporate tax on its profits, and then shareholders pay a second time on any dividends they receive.
Which business structure pays less taxes?
There is no single “cheapest” structure; the answer depends on your revenue. For many small-to-mid-sized businesses, an S Corporation is often the most tax-efficient because it allows owners to split income between a “reasonable salary” (subject to payroll taxes) and “distributions” (which are not). However, a C Corporation may be better if you plan to reinvest all profits back into the company.
Because the 2026 tax landscape includes new updates to the SALT (State and Local Tax) deduction caps and bonus depreciation, consulting with the team at Schneiders & Associates, L.L.P. can help you find the specific structure that maximizes your bottom line.