A sole proprietorship is taking on a new partner. Since both persons are still in an early startup phase, they need to decide on a startup business entity structure. Under consideration is a California LLC and a decision needs to be made how to tax the LLC as a partnership or S-Corp or C-Corp. It goes without saying that liability is a major consideration and simplicity, lower overhead, and lower taxes are key considerations. If The LLC taxed as an S-Corp pays lower taxes and the members are not considered employees like a C-Corp, would the members pay less income taxes and avoid California workers' comp? Thanks.
Unfortunately the answer to your question is highly individual. What is best will depend on both the finances of the company, your own finances, how the business is capitalized and other things as well.
There is no one-size-fits-all answer to this question. You need to talk to a qualified tax preparation professional (CPA or Enrolled Agent). That person can understand all the issues that are involved and only then suggest the proper formation for your business.
I believe the issue of members and employment income vs dividends/distributions is the same for partnerships, S-corps and C-corps. If a member performs services for the entity, they must be paid wages, although those wages need not necessarily be their entire income from the entity. Reasonableness applies, and the wage portion of their income must be a reasonable wage given their services provided. This is a major point of contention with the IRS for many entities, perhaps because they attempt to low ball the wage portion of the income.
I think the members would pay the same California income tax for wage income or non-wage income from the entity.
As to workers comp, I am not an expert by any means, but see California Labor Code sections 3351(f) and 3352(a)(17):
3351.
?Employee? means every person in the service of an employer under any appointment or contract of hire or apprenticeship, express or implied, oral or written, whether lawfully or unlawfully employed, and includes:
(f) All working members of a partnership or limited liability company receiving wages irrespective of profits from the partnership or limited liability company. A general partner of a partnership or a managing member of a limited liability company may elect to be excluded from coverage in accordance with paragraph (17) of subdivision (a) of Section
3352.
3352.
(a) ?Employee,? excludes the following:
(17) (A) An individual who is a general partner of a partnership or a managing member of a limited liability company who executes a written waiver of his or her rights under this chapter stating under penalty of perjury that the person is a qualifying general partner or managing member. The waiver shall be effective upon the date of receipt and acceptance by the partnership?s or limited liability company?s insurance carrier. The insurance carrier, with the consent of the individual executing the waiver, may elect to backdate the acceptance of the waiver up to 15 days prior to the date of receipt of the waiver. The insurance carrier, insurance agent, or insurance broker is not required to investigate, verify, or confirm the accuracy of the facts contained in the waiver. There is a conclusive presumption that a person who executes a waiver pursuant to this subdivision is not covered by workers? compensation benefits.
You might want to check the rest of section 3352 to see if anything else applies.
Do not overlook the new California PTE tax scheme which serves as a work around for the federal SALT deduction limitation. Depending on the income level of the entity and individuals, this may or may not work as a significant savings on federal individual income taxes. If so, this would lead to you opting not to tax the LLC as a partnership, but as a corporation, most likely an S-corp.
Here are a couple links, there are others:
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I think the advice given to seek guidance from a knowledgeable professional is good advice. Who knows what else you should be considering given your specifics, and even your plans for the future. But I think you are asking good questions, and now is the best time to be asking those questions, and getting that professional advice.
This is a very useful opinion. ...... A general partner of a partnership or a managing member of a limited liability company may elect to be excluded from coverage in accordance with paragraph (17) of subdivision (a) of Section
3352. ...... It appears that there is an exception that may apply to a partnership or an LLC that elects to be taxed as a partnership or S-Corp but not a C-Corp. The other point of the California PTE tax scheme is an interesting point as well which I did not think about to ask.
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