Limited liability companies
If I were to start a new business with a partner, is a Limited Liability Company our best option for us? Also, please explain how this type of entity is taxed.
A
State registered limited liability companies are a relatively new form of business entity. An LLC can be taxed as a partnership for federal income tax purposes, but its members (similar to partners), like corporate shareholders, are not personally liable for the entity's liabilities and debts.
Unlike limited partners, LLC members may participate in management without risking personal liability.
California authorizes the formation of LLCs and also allows foreign LLCs to qualify to do business in California. LLCs classified as partnerships or that are disregarded and taxed as a sole proprietorship (single member LLC) for California tax purposes are subject to minimum taxes and fees. LLCs classified as corporations remain subject to the same tax return and tax payment requirements as any other corporation.
The annual minimum tax for an LLC is $800. Please note that first-year LLC's are exempt from the minimum tax……. California is running a sale! Additionally, every LLC classified as a partnership or treated as a sole proprietorship and subject to the minimum tax must pay an annual fee as follows: $900 if the total income of the LLC from all sources reportable to California for the taxable year is $250,000 or more, but less than $500,000; $2,500 if the total income is $500,000 or more, but less than $1 million; $6,000 if the total income is $1 million or more, but less than $5 million; and $11,790 if the total income is $5 million or more.
Please note that “total income” means gross income plus the costs of goods sold that are paid or incurred in connection with the trade or business. Therefore, the tax is not based upon the net income of the business, but rather the gross income.
For example, if your business were to gross $500,000 and you were to lose $100,000 (heaven forbid), you still would be liable to pay California a fee of $2,500. Whereas, if you were an S corporation given the same facts, you would be liable for the $800 minimum S corporation tax. Both entity types would still pass through its $100,000 loss to its members (or shareholders).
If your business is a “high volume” type business you need to evaluate whether the LLC tax structure works for you. You may want to consider the S corporation entity as an alternative to achieving the limited liability objective or just electing to have the LLC be treated as an S corporation for Federal and California purposes.