Since most businesses need to generate at least $250,000 in gross receipts just to break even, the California LLC will have to pay a higher franchise tax than a California corporation, even if the LLC is operating at a real loss. By contrast, no California corporation is subject to a gross receipts tax. Like most other forms of businesses (sole proprietorships, partnerships, trusts), a California corporation only pays tax on its net taxable income (with the exception of California's state minimum franchise tax of $800 which is applied toward the taxes owed).

Increased Self-Employment Tax

The second reason why a California LLC should not be used to operate a business is the increased self-employment tax each of the members will pay. A California LLC is treated either as a disregarded entity (sole proprietorship) when it has a single member or as a partnership if it has two or more members, unless it elects to be treated differently. Net income generated by any business conducted by the LLC is consequently treated as self-employment income and taxed at 15.3% for FICA in addition to the ordinary federal and state income taxes. By contrast, the shareholders of a California corporation do not pay any self-employment tax; they only pay a 15% capital gains tax on profit distributions. The California S- Corporation only pays 7.65% employment taxes on the declared salaries of its officers and employees. Typically a California S- corporation will provide its shareholder-employees with a reasonable salary from which employment taxes are paid and the balance of any profits via a dividend which is not subject to income or payroll taxes, but merely the 15% capital gains rate.

Potential For Higher Income Tax

The Third reason why a California LLC should not be used to operate a business is the high probability that the LLC members will have to pay income taxes on money they never actually received. If the LLC uses some its profit to build inventory, or to acquire assets, the members will be required to pay self-employment tax on the value of the inventory even though they never received a dime.

Due to the multitude of tax disadvantages that burden the California LLC, it is a very expensive means to operate a business. It is therefore typically in the owners best interest to form a corporation, rather than a LLC, unless the entity is being formed to hold real estate.

If you would like to retain the services of Melissa C. Marsh to form and organize a California corporation or California LLC, please call 818-849-5206 or Send us an Email.

© 2009 Melissa C. Marsh. All Rights Reserved.