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Contractors: Choosing Between an S-Corp and LLC for your California Business

Posted by HMS Law Group | Nov 17, 2016 | 0 Comments

Photo provided by The Sacramento Bee

The downtown Sacramento skyline is changing. As we watch the arena construction from our office window, it's clear that the real estate market is on an upswing, leading many construction-based businesses to reconsider their legal structure. Over three years has passed since California began allowing Limited Liability Companies (LLCs) to be registered with the Contractors State License Board(CSLB). This evolution in California law gives contractors more options to evaluate when determining their optimal business entity structure. If you have been operating as a sole proprietor or general partnership, recent changes to the law probably have you wondering whether there are legal advantages to establishing your business as a Limited Liability Company (LLC) or a Corporation (Corp).

The LLC: A Relatively New Option for California's Building Industry

Previously, many California contractors chose to incorporate to gain the personal asset protection not provided by a partnership or proprietorship. The LLC is now an option for contractors to obtain similar asset protection without many of the corporate formalities like holding periodic shareholder meetings and recording minutes. Limited Liability Companies have traditionally enjoyed several distinct legal benefits, including the aforementioned protection of personal assets from claims against the company, flexible management structures, ease of ownership transfer, and pass through taxation. However, LLCs generally remain subject to the same federal self-employment tax requirements  as sole proprietorships and partnerships. And California contractors who choose the LLC form are faced with a web of additional considerations beyond the traditional legal contours of an LLC.

In California, contractors who choose the LLC form of business must consider the costs and effects of several additional requirements imposed under state law. First, a California LLC must file a biennial report and pay a minimum franchise tax of $800 per year. Second, California LLCs are subject to an annual fee based on gross receipts; that fee varies on a sliding scale from $900 to $11,790, relative to the total gross receipts reported by the LLC. Third, contractors in LLC form must post a surety bond of $100,000 as a condition precedent to licensing or renewal. This bond is in addition to the performance, payment, or combined “contractor's bond” that would be secured in the general course of business on a project-specific basis. Fourth, a builder LLC with five or fewer “personnel of record” must carry aggregate insurance of $1,000,000, with an extra $100,000 for each additional person after the fifth. And finally, the law requires a builder LLC to post a $12,500 bond for the company's qualifying individual when that individual owns at least ten percent of the LLC. All of these amounts are in addition to the Commercial General Liability Insurance and performance or payment bonds that would be secured in the ordinary course of business as a contractor.

The Corporation: Still a Popular Choice for California's General Contractors

A Corporation issues stock, is governed by a corporate board, has shareholders, and provides similar protection from liability as an LLC. An S Corp has features that may be advantageous or disadvantageous, depending on your specific business situation and needs. As with an LLC, the personal assets of an S Corporation's shareholders cannot be seized in order to fulfill the business's financial obligations or liabilities. The S Corp is also treated as a pass-through entity for federal tax purposes. But individual shareholders of an S Corp can reduce self-employment tax liability and avoid the double taxation of a C Corporation (taxation at the corporate and individual level) by functioning as employees with a combination of wages and dividend payments or tax-free dividend payments.

These considerations should be balanced against the added formalities required to operate an S Corp as a going concern, which require additional time and effort. For specific questions regarding whether the LLC or S Corp business structure would best suit your particular situation, contact an attorney at HMS Law Group LLP. Our attorneys are experienced at helping California contractors navigate the complex legal environment to find their optimal business form.

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