What is a California LLC?
An LLC is a Limited Liability Company business entity type that allows business owners (“members”) to enjoy tax flexibility and personal liability protection without extensive and complicated compliance requirements. Essentially, operating as a California LLC combines the limited liability features of a Corporation with administrative simplicity similar to that of a Sole Proprietorship or General Partnership.
A Limited Liability Company may have one owner (single-member LLC) or multiple owners (multi-member LLC). Multi-member LLCs may be member-managed or manager-managed, and they may have an unlimited number of owners.
The California Secretary of State is the state government office that keeps record of all domestic and foreign business entities registered to operate in the state. Domestic LLCs in California are those that are on record as having California as their home state (their state of domicile). Foreign LLCs are those that are formed in a state other than California but that apply for foreign qualification to conduct business there.
Legal and Tax Considerations of an LLC
An LLC is considered to be a separate legal entity from its members. So, if the business gets sued or faces financial difficulties, generally, the owners’ personal assets are not at risk of being used to settle those debts.
By default, the IRS treats LLCs as a pass-through entity—it considers the LLC and its members as the same tax-paying entity. Profits, losses, and income tax obligations flow through to the LLC’s owners’ personal tax returns. Qualifying Limited Liability Companies may instead choose to be taxed as an S Corporation. S Corp tax treatment is also on a pass-through basis. However, how self-employment taxes (Medicare and Social Security) are applied is different than how they are handled with the default LLC tax treatment. Normally, all of an LLC’s profits are subject to self-employment taxes. Alternatively, with the S Corp tax election, only owners’ salaries and wages are subject to those taxes. Compensation paid as distributions to members is subject to federal income tax but not self-employment taxes.
Potential Benefits of Forming an LLC
- Limits the owners’ personal liability for the business’s debt and legal issues.
- Allows for the transfer of ownership – If a member leaves or dies, an LLC’s operating agreement should have provisions for how that member’s ownership stake should be handled.
- The business may survive beyond a member’s lifetime because an LLC is a legal entity separate from its owners.
- Has fewer corporate formalities than a corporation – e.g., no bylaws, board of directors, shareholder meetings, etc.
- May have an unlimited number of members.
- Provides ownership flexibility – LLC members do not need to be U.S. citizens or have permanent residences in the state.
- Offers tax treatment flexibility – Members may choose to be taxed as either a Partnership (or Sole Proprietorship if a single-member LLC) , S Corporation, or C Corporation.
How to Form an LLC in California
Some of the steps involved in starting an LLC in California include:
- Choose a name for the LLC – Do a name search to make sure it’s available in the state.
- Designate a Registered Agent – An LLC must designate a Registered Agent authorized to accept service of process (important government documents and legal notices) on behalf of its business.
- Prepare and submit the required business registration documents – To register a Limited Liability Company (LLC), business owners must file Articles of Organization with the California Secretary of State, Corporations Division.
- Create an LLC Operating Agreement – The LLC operating agreement sets the rules for how an LLC will be run and describes the roles and responsibilities of the LLC members.
- Obtain an EIN – An Employer Identification Number (Federal Tax ID Number) is a unique nine-digit number issued by the IRS. It’s used for tax purposes and may be required for setting up a business bank account and other accounts.
- Obtain the necessary business licenses and permits – Depending on the type of business the LLC conducts, there may also be state, federal, or local business licenses and permits required to legally operate.
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