When starting a business in California, one of the most important decisions the prospective business owner will make is which type of business entity to choose. The most common types of business entities formed in California are Sole Proprietorships, Limited Liability Companies, Corporations, and Partnerships. The business owner must choose which one will best meet the needs of the new business, taking into account the complexity of the business, tax consequences, owner liability, and protection of the owner’s personal assets.

A Sole Proprietorship is the simplest way to operate a business. In a Sole Proprietorship, the business has only one owner and operates the business without the use of a business entity such as a Corporation or Partnership. A Sole Proprietorship avoids much of the complex requirements characteristic of other business entities. Also, the business income and expenses are run through the business owner’s personal tax return which can expose the business owner to increased personal tax liability. A significant downside of a Sole Proprietorships is that not only are the business owner’s personal assets exposed but also the business owner is personally liable for the business operations and obligations.

A Limited Liability Company, typically referred to as an LLC, can be used to operate a simple or a complex business. It is relatively easy to set up a Limited Liability Company and typically is not complex to operate and maintain. Limited Liability Companies can be owned by one or several individuals who are called Members. For tax purposes, Limited Liability Companies can elect to be taxed either as a Partnership, where tax liability “passes-through” the Limited Liability Company to its Members individually, or as a Corporation, where the Limited Liability Company reports and pays taxes on its income. Limited Liability Companies are also subject to an annual minimum franchise tax assessed by the State of California Franchise Tax Board. A benefit to operating a business as a Limited Liability Company is that in many cases the Limited Liability Company can offer its Members personal asset protection and limit the Members’ personal liability for business operations and obligations.

As a business entity, Corporations are best used for moderate to complex businesses. Corporations come in all shapes and sizes as they can be “for-profit” or “non-profit” businesses and can be small to extremely large in size. Corporations are owned by one or more Shareholders and are governed by a Board of Directors who direct the Corporate Officers to carry-out business operations. Because of this, Corporations are considered to be more complex business entities to operate and maintain. Corporations are taxed as a separate business entity from its owners which may result in double taxation. A significant benefit of a Corporation is that generally it offers its shareholders, directors, and officers personal asset protection and personal liability protection from Corporate business operations and obligations.

Partnerships, like Corporations, come in all shapes and sizes in that there can be General Partnerships, Limited Partnerships, or even Limited Liability Partnerships. In each case, Partnerships can be simple or complex and require that two or more individuals called Partners, own the Partnership. Taxation depends upon the type of Partnership but typically Partnerships are not taxed at the entity level. Instead, tax liability usually “passes-through” to its Partners. Partnerships, like Limited Liability Companies, may be subject to an annual minimum franchise tax assessed by the State of California Franchise Tax Board. A Partners’ personal asset protection and liability protection for business operations and obligations depends specifically on whether the Partnership is a General, Limited, or Limited Liability type Partnership.

Ultimately, when starting a business it is important that the business owner select the right business entity. Because this is a decision which affects nearly every aspect of the business, it should not be taken lightly. It is best to seek the counsel of an attorney in making the correct decision about which business entity is the right one for the particular business and business owner.


– Gregory J. Chilina, Attorney at Law