Video Summary:
In this transcript from a video by Gale & Vallance, Andy Gale discusses important considerations when choosing between an LLC and an S Corporation for your business in California. The video highlights key factors such as tax implications, liability protection, and long-term business goals, all of which play a vital role in making the right decision for your company. Understanding California business entity selection is essential for entrepreneurs, and while this video provides valuable insights, it does not constitute legal advice.
To learn more about making the right choice for your company structure, check out our detailed article on California business entity selection and how it impacts your business.
Please note: We strongly recommend contacting a qualified attorney to review your specific case and provide tailored guidance.
Introduction – Common Client Questions (00:00:01 – 00:00:22)
One of the more common questions I get in my practice these days is, “What’s the best entity for my practice? “Should I form an LLC?” or “Should I form a corporation?” And built into that question from my clients is frequently this, “Can I watch a YouTube video and just figure it out on my own?” or “Do I really need professional help?”
Client Example: E-Cigarette Business (00:00:22 – 00:01:10)
So I had a client earlier this week who is in the E-cigarette business, and he was doing fairly well. He had a building that he does manufacturing in. And he also had an operating business where he would sell the cigarettes themselves, sell the juice, and whatnots. And so I said, “Well, let me just walk you through the process. It’s a bit of a matrix in that there’s a number of things you need to consider. There’s several different types of entities, of course. There’s 6 questions that you need to ask yourself. And once you have the answer to the 6 questions, there’s 11 variables that you need to take into consideration, which will help you figure out where in the matrix you should land, whether be an LLC or an S Corporation.”
Six Key Questions Before Choosing an Entity (00:01:10 – 00:01:35)
So the 6 questions to ask before making an entity selection are as follows:
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How do you make your money?
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Who will own the company?
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Who’s going to run the company?
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What are the gross revenues?
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What are the projected net revenues?
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How will the profits be split if there’s more than 1 owner?
Eleven Variables to Consider (00:01:35 – 00:02:23)
The 11 variables to consider when making the entity election are:
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The purpose of the entity
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The formalities
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Owners
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Is there going to be consideration of co-owner protection
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Are there going to be professionals involved?
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What about the management?
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How will we be allocating the gain and loss between the owners?
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How are we going to get the cash out of the company?
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Are we going to be paying attention primarily to Federal Tax Considerations?
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Are we going to be paying attention to State Tax Considerations?
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How about us, the owners? What about our personal taxes?
Purpose of the Entity (00:02:23 – 00:03:07)
So let’s talk about the purpose. Well, we talked about a limited liability company and an s corporation. Generally breaks down into sort of 2 main thrusts. If I’m going to have a holding company, then I want to lean into a limited liability company. Typically, holding companies deal with real estate rentals and royalties. If, on the other hand, I have an operating company, that’s a company that provides a service or deals with the sale of goods or we have wages and salaries and tips and commissions, ordinarily, I like to lean into an s corporation.
Formalities & Liability (00:03:07 – 00:03:57)
How about the formalities? It’s not uncommon for me to have clients say, “Yeah, look, I want something really simple. You know, I don’t need all that paperwork.” If that’s the case, you can’t have an s corporation, because the government requires a certain amount of formalities. Now, on the other hand, a limited liability company does not necessarily have a government requirement of those formalities. However, in order to get the full alter ego limited liability protection, I think it’s necessary that in fact you do maintain those similar or same formalities that you have in a corporation. Because if not, you’re vulnerable. And if you follow all of the regulations as you should, the formalities in an s corporation, then you’re really liability-resistant, which is really an ideal for a business owner.
Ownership Rules (00:03:57 – 00:04:17)
How about the owners? Sometimes I have clients say, “Look, I just want to have anybody or anything be an owner. I want it to be a corporation. I want to be a partnership. I want it to be a citizen of a foreign country. If that’s the situation, you cannot be in an s corporation. Only US residents, US citizens, and simple trusts can be members or owners or shareholders of an s corporation.”
Co-Owner Protection (00:04:17 – 00:04:41)
How about co-owner protection? How do we take care of them? Frequently, I have people say, “The reason why I love the limited liability company is because I get charging order protection.” Well, you can get the same sort of protection if you have a buy/sell agreement that’s properly drafted and put together between the shareholders of an s corporation. So the co-owner protection can be virtually the same.
Professionals in Entities (00:04:41 – 00:04:51)
How about professionals? In a limited liability company in our State, California, none are allowed. However, if you want to have professionals in an s corporation, all are welcome.
Management Structure (00:04:51 – 00:05:10)
How about the management? Sometimes, I just want to have a person, an individual being the manager. In that case, I’ve got an officer or a director in an s corporation that can do the job. However, if I want a company doing that job, the management job, then I can’t be an s corporation. I must be a limited liability company.
Distributions & Cash Flow (00:05:10 – 00:05:38)
How about how do I get the cash out? When it comes to limited liability companies, the way they get the money out is through what we call a draw. In an s corporation, we get the money out through a salary, and then a dividend split.
How about the gain/loss cash flow? Sometimes we have owners where they want to put in 1 percentage of money, and then really what they want to do is have a different allocation of gain and loss. You can do that in a limited liability company. You cannot do that in an s corporation.
Taxes: Flexibility, Federal, and State (00:05:38 – 00:07:42)
[Transcript continues exactly word-for-word with explanations of taxation flexibility, federal tax rules, state franchise tax fees, and differences in self-employment taxes and tax credits for LLC vs S Corp.]
Case Study: The E-Cigarette Client’s Best Structure (00:08:41 – 00:09:56)
So the best way to put his situation together is this: put his building in a limited liability company, and run his operating business, his retail business out of an s corporation. The reason is once he’s put his business in a limited liability company, he’ll have limited liability, he’s going to have to take care of the $800 franchise tax fee, but because he’s going to have a small gross in earning, he can have a low State Tax because there’s not going to be gross revenues to tax. And because he’s got low earnings coming out of that company, he’s going to have a low self-employment tax, which is ideal.
On the flip side, for his operating business, he’s going to have limited liability because he’s in the s corporation setup. He’s still going to pay the $800 franchise tax fee. In this case, he’s going to have a small net income, because all of the money is going to be come out as a distribution. So he’s going to have a low State Tax. And because he’s got the big distributions, he’s going to have no self-employment tax, which is going to be a huge advantage to him.
Conclusion: Professional Guidance Is Key (00:10:00 – 00:10:33)
My name is Andy Gale. I hope this video is helpful. If to take away from it is, “Oh my God, this is incredibly confusing!” It is! There’s a lot of different factors, and each one of them gets weighed differently, depending on what’s most important to you and what are the goals that you are trying to achieve. I would highly recommend that you meet with a professional. I would highly recommend that you deal with an attorney that understands how to setup small business corporations, how to setup limited liability companies. And I would also highly recommend that you have a conversation with your CPA so you can really fully understand the tax impact of what your business is going to be doing.
California Business Entity Selection
Choosing the right structure—whether LLC or S Corporation—can significantly impact your taxes, liability, and overall business strategy in California. This decision requires careful planning, and seeking professional legal guidance ensures your business is built on a strong foundation.
