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California LLC

For California LLC prices and State fees, please visit the costs page for forming an LLC in California.

Forming a California Limited Liability Company (“LLC”) can be a beneficial formation option for your company, especially if you intend to have multiple members and are looking for partnership-type taxation and management qualities, with corporation-like limited liability. As the name implies, a Limited Liability Company offers members limited liability protection from debts and lawsuits. Although California does not provide a pure “pass through” entity status for LLCs, the associated franchise fee is minimal in comparison with the benefits offered by a California LLC.

Lets examine what some of these factors, advantages, and even disadvantages might be.

Forming a California LLC

Establishing your LLC in California will allow your company the flexibility to add members, benefit from decreased taxation (by avoiding the “double taxation pitfall” of a standard corporation), and will give your company unparalleled flexibility with respect to how it is organized, how distributions are handled, and how it is run. In effect, your business can reap the benefits and flexibility of a partnership while enjoying the same protections from liability and debt that a corporation provides.

In addition to the limited liability protection, there are also substantial tax benefits to be garnered from the formation of an LLC. The LLC has the “check box method” of taxation available to it, wherein it can choose to be taxed as a “standard” corporation, with the LLC being taxed at the company level, then the members for individual distributions. Or, the LLC can elect to be taxed as a partnership, with “pass through” taxation, with no tax at the LLC level (with the exception of the franchise fee). This garners great flexibility with respect to business and taxation strategies, and can amount to a substantial savings.

Once the election to form an LLC is made, it is imperative that a well-written Operating Agreement be drafted that specifically outlines the distribution methods, rights and benefits of members and the managing member, capitalization, and any other rights, duties, assignments and responsibilities necessary for the proper operation of the LLC. The Operating Agreement can be compared to the bylaws of a corporation, wherein a properly written one, and strict adherence to it, helps to ensure the “corporate veil” protection of the LLC.

Another often-cited benefit of an LLC is that it is not subject to the same, stringent corporate formalities that a C or S corporation is subject to. It can be simpler to establish and run an LLC, provided that a quality, well written Operating Agreement is in place.

A California LLC allows for as few as one member or as many members as your company is willing to have, with no limitations on numbers, and no limitations with respect to types of stock. The company must select a managing member who is typically the figure head of the organization and is responsible for it’s management. The profits or losses of the business organization pass directly through to the Member's personal income tax return (“pass through taxation”), with no taxation at the LLC level. The net profit of the LLC is not considered to be income earned by the Members (though it can be for the Managing Member as a special “fringe benefit” treatment--see below), and thus is not subject to self-employment tax.

Advantages and benefits of forming a California LLC

California LLC members enjoy Limited Liability, which means they are mostly personally protected from any liability of the LLC and successful judgments, as well as from the LLC itself.
A California LLC allows for “multi-tiered” ownership wherein an S or C corporation can be a member--this can allow for substantial tax benefits, and increased liability protection.
California allows for “single member” LLCs.
The LLC allows for the "special allocation" of profits--the disproportionate splitting of Member profits and losses (in different percentages than their respective percentages of ownership). This means that Members can enjoy the benefits of receiving profits (and writing off losses) in excess of their individual ownership percentage, so long as it is clearly delineated in the Operating Agreement.
Managing Members' share of net profit is considered earned income because the Managing Member is considered to be an active owner--therefore qualifying the Managing Member for special "fringe benefit" treatment.
The Members' share of the bottom-line (“net”) profit of an LLC is not considered earned income, and therefore is not subject to self-employment tax.
Members are compensated using either distributions of profit or guaranteed payments. A distribution of profit allows each member to pay themselves by merely writing checks--whenever they need the money (provided the business has the available cash). Guaranteed payments represent earned income to the members, thereby qualifying them to enjoy the benefits of tax-favored “fringe benefits.”
The Managing Member of an LLC can deduct 100% of the health insurance premiums he or she pays, up to the extent of their pro-rata share of the LLC's net profit, because the profit is considered earned income. Note: If a member has earned income, he or she will also qualify.
A Corporation can be a member of an LLC. This allows you to create an additional level of ownership, which is designed to create an entity that can offer such traditional “fringe benefits” as retirement plans and an additional level of protection from liability.
As a Member, you can contribute capital or other assets to the LLC, or loan the LLC money to put dollars or value into the business. You can take dollars out by taking a repayment of your loan (plus interest), a distribution of profit or a guaranteed payment. If any of the members die, the LLC can continue to exist--subject to the unanimous positive vote on the part of all remaining members or a proviso in the Operating Agreement.
Tax Advantages. Because of the “check box” taxation election flexibility, you can tailor your LLC’s taxation method to best suit your goals and strategies, weighing the various options and electing the method that allows your LLC to retain the largest share of its net profits.

California LLC Fees and Costs

In addition to the $800 minimum tax, an annual LLC fee is imposed based upon total income from all sources reportable to California (range from $500 to $4,000). Non-resident members may either file a group non-resident return and pay California income tax; or file a Form 3832 consenting to the jurisdiction of the state of California. If any LLC member fails to sign Form 3832, the LLC is required to pay tax on the member’s distributive share at the highest marginal rate (11%).

Charging Order

If a judgment is awarded against the LLC itself, it may be levied, and LLC’s property seized or sold in payment, much in the same manner that a corporation would be treated. Conversely, if a judgment is awarded against a particular member, and with a properly written operating agreement stating as such, distribution usually cannot be compelled to satisfy a member’s judgment debt (this is why it is critical to have a well crafted operating agreement, you’re your protection be mitigated). Creditors or judgment debtors have to satisfy themselves with a “Charging Order” that grants them rights to distributions made by an LLC to a particular member named in the judgment. This gives them the rights to that distribution, but does not affect the rights, assets, or distributions of other members or of the LLC as a whole. These types of protections characterize the attraction to LLCs by potential investors.

It should be apparent that forming your LLC in California offers a substantial amount of flexibility and benefits to your company, especially if you intend to conduct business in this state. Protection from liability, asset protection, and taxation savings are all representative benefits of a California LLC. California will not only help you and your company enjoy the corporate benefits of limited liability, greatly reduced taxation and financial privacy, but with a diligent implementation and business development strategy, you can build your business into a highly competitive, investment-attracting entity.