Should I Create an S-Corp or C-Corp in California?

Getting your business started off right starts with selecting the optimal entity structure for your company. Two common options are S-Corporations (S-Corps) and C-Corporations (C-corps). They both have unique characteristics and benefits, especially when evaluated in the context of California’s existing business regulations.

Understanding the Basics

Both S-Corps and C-Corps are business entities that offer limited liability protection to their shareholders, but they differ in terms of taxation, ownership requirements, and operational and reporting formalities. The most significant distinction between them is how they are taxed. A C-Corp is subject to double taxation in which the corporation is taxed on its profits, and the shareholders also pay taxes on individual dividends. An S-Corp is a pass-through entity that can avoid double taxation because all profits and losses are passed through to the individual shareholders’ tax returns. 

Both S-Corps and C-Corps require the adoption of bylaws, holding regular shareholder and director meetings, and maintaining detailed corporate records. However, C-Corps generally have more extensive formalities because of their ability to offer a wider variety of services since there are many types of business that are not eligible for S-Corp status. Both types of corporations must meet compliance requirements in order to continue receiving the benefits that these corporate structures have to offer.

Ownership Structures

Another key difference between S-Corps and C-Corps is the regulations around ownership. A C-Corp offers more flexibility and can have an unlimited number of shareholders. The ownership can be held by individuals, other corporations, as well as foreign entities. S-Corps have additional restrictions, such as a shareholder cap of 100. All shareholders must also be U.S. citizens or permanent residents. 

The differences in ownership structure can provide a lot of benefits depending on the size and operations of the business. Since an S-Corp is considered a pass-through entity, it has the ability to pass through losses to shareholders, which they can then use to offset other income on their personal tax returns. There is a lot of potential for tax savings in other areas like employment taxes, which makes it appealing for some business owners.

A C-Corp may be more beneficial for those who seek to raise capital through venture capitalists or public offerings. They’re an attractive option for investors because they can offer different classes of stock. C-Corps can also offer employee stock ownership plans (ESOPs), which is a great way to increase employee loyalty.

What Makes California Different

Both S-Corps and C-Corps created in California will follow federal tax filing rules, however, as usual, California adds some hurdles. California imposes additional corporate income tax on both types of corporations. Although S-Corps are not double-taxed federally, on a state level, they’re still taxed on profits. Additionally, any corporation established in California starts as a C-Corp by default. Any eligible company that starts as a C-Corp in California can become an S-Corp at any point after that, but they need consent from all shareholders. This is an important consideration because clear expectations must be communicated before creating the business in order to avoid disagreements on whether to continue as an S-Corp or a C-Corp.

These are just some of the many pros and cons to be weighed when deciding on the best corporate formation for your business, and there are other entity types to consider as well. Seeking strategic guidance from an attorney is a good way to secure some legal “piece of mind” about the best business structure for you, so call us at (925) 399-1529 (1LAW) for a free consultation today.

Integrated General Counsel