Choosing the Right Business Entity in California: Legal and Tax Considerations
August 2025 | By Jonathan S. Ro, Esq., Ro Law Firm | jonathan@jsr-law.com
The entity you choose may affect your personal liability, tax obligations, management structure, and perhaps even your ability to attract investors. Below, we outline the main entity types available in California, and what factors to consider when setting up a new company, including the often-overlooked California Close Corporation.
1. Sole Proprietorship
A sole proprietorship is the simplest form of business—just you, operating without forming a separate legal entity.
Pros:
· Minimal setup and cost.
· Complete owner control.
Cons:
· Unlimited personal liability—your personal assets are at risk for business debts.
· No legal continuity if the owner leaves or passes away.
Tax:
· Report income on your personal tax return (Schedule C).
· Subject to self-employment tax.
· Losses can offset other income.
2. General Partnership
A general partnership is formed when two or more people carry on a business together for profit, even without a written agreement (though one is strongly recommended).
Pros:
· Easy to form.
· Shared resources and responsibilities.
Cons:
· Joint and several liability—each partner is fully liable for all partnership obligations.
· Each partner can bind the partnership without the other’s consent.
Tax:
· Pass-through taxation via Form 1065 and K-1s.
· Partners pay self-employment tax on their share of income.
3. Limited Partnership (LP)
An LP has at least one general partner (unlimited liability) and one or more limited partners (liability limited to their investment).
Pros:
· Limited partners enjoy liability protection.
· Can attract passive investors.
Cons:
· General partner remains personally liable.
· Requires filing with the California Secretary of State.
Tax:
· Pass-through taxation.
· Limited partners generally avoid self-employment tax unless active.
4. Limited Liability Company (LLC)
An LLC offers liability protection for all members and flexible management structures.
Pros:
· Liability protection for all members.
· Flexible governance—member-managed or manager-managed.
· Fewer corporate formalities than a corporation.
Cons:
· Higher California costs: $800 annual franchise tax plus gross receipts fee for income over $250,000.
Tax:
· Pass-through by default (single-member = Schedule C; multi-member = partnership return).
· Option to elect C or S corporation tax treatment.
· Subject to CA’s annual LLC fee.
5. Corporation (C Corporation)
A C corporation is a separate legal entity owned by shareholders, managed by a board of directors.
Pros:
· Strong liability protection.
· Unlimited life—continues despite ownership changes.
· Attractive to investors.
Cons:
· More formalities (bylaws, meetings, minutes, stock issuance).
· Higher compliance costs.
Tax:
· Subject to “double taxation”: corporate profits taxed at the federal (21%) and California (8.84%) levels, plus taxes on shareholder dividends.
· Subject to California’s $800 annual minimum franchise tax.
· No self-employment tax on dividends.
6. S Corporation
An S corporation is not a different legal entity—it’s a tax election available to eligible corporations (and some LLCs).
Pros:
· Same liability protection as a C corporation.
Cons:
· Must meet eligibility rules: ≤100 shareholders, all U.S. individuals, one class of stock.
Tax:
· Pass-through taxation—no federal corporate income tax.
· California imposes a 1.5% corporate-level tax.
· Subject to California’s $800 annual minimum franchise tax.
· Only reasonable shareholder salaries are subject to payroll tax; distributions are not.
7. California Close Corporation
A California Close Corporation is a special corporate form for small businesses with no more than 35 shareholders.
Pros:
· Can dispense with a board of directors; shareholders may manage directly.
· Flexible governance via shareholder agreements.
· Same liability protection as a standard corporation.
Cons:
· Must state “close corporation” status in articles of incorporation.
· Restrictions on share transfers make it less appealing to outside investors.
Tax:
· Same as other corporations: default C corporation taxation or S corporation election.
· Subject to California’s $800 annual minimum franchise tax.
8. Limited Liability Partnership (LLP)
An LLP is primarily for certain licensed professionals (lawyers, accountants, architects).
Pros:
· Protects partners from liability for each other’s malpractice.
· Pass-through taxation.
Cons:
· Restricted to certain professions in California.
· Requires registration and compliance with CA rules.
Tax:
· Partners pay self-employment tax on their distributive share.
· $800 annual minimum franchise tax applies.
Comparison Table
Which Entity is Right for You?
Your choice should be guided by:
Liability concerns—Do you want to protect personal assets?
Tax strategy—Will you benefit more from pass-through taxation or corporate structure?
Investor needs—Do you plan to bring in outside funding?
Formality tolerance—Are you comfortable with ongoing compliance obligations?
Bottom Line:
Selecting the right entity in California is more than a paperwork decision—it’s a strategic move that impacts your taxes, liability, and growth potential. If you’re unsure which structure fits your needs, our firm can help you weigh the legal and tax implications and file the necessary formation documents with the California Secretary of State.
Our attorneys are ready to help you. Contact the Ro Law Firm today for a personalized consultation at (725)222-0236.
Disclaimer: This article is for informational purposes only and does not constitute legal advice. No attorney-client relationship is formed by reading this article or contacting the firm without a signed engagement agreement.