Who cannot be an LLC: Some businesses which must be licensed by the state of California are not allowed to be LLCs. The Secretary of State has never issued a list of which businesses can and cannot form LLCs, but there have been some rulings on specific occupations. If your occupation requires a state license, you should check with the Secretary of State or an experienced tax accountant before forming a California LLC. A company which is organized as an LLC in spite of being ineligible loses many of its legal protections. The Contractor State License Board can issue a contractor's license to an LLC. However, the company is required to either carry $1 million of liability insurance or have $500,000 of liquid assets, so it is likely than only larger contractor companies will take advantage of the opportunity to operate as LLCs.
Who cannot be an S Corporation: All shareholders of an S corporation must be either citizens or residents of the United States. All of the shareholders must be individuals or estates, with a few exceptions. All of the shareholders must have identical rights to distributions and liquidation proceeds. There are additional restrictions; check with your tax accountant.
Reasons in favor of an LLC
Reasons in favor of an S corporation
Other things to consider:
You can create an LLC, and then elect to be taxed as an S corporation. Legally, you remain an LLC. This is a private agreement between you and the IRS. California goes along, too.
You may have noticed that I have not mentioned how quick and easy it is to form an LLC as a factor in favor of LLCs. This is because I strongly believe that if a company has more than one owner, it is critical that you take the time to make a written agreement before the start of business. It should address how profits & losses are to be shared, what happens if the company needs additional capital, what happens if an owner is disabled, dies, or decides to leave the company, and many other questions.
Whether you choose an LLC or an S corporation, your business should carry a large amount of insurance.
Other factors will also influence your choice of entity. The purpose of the information presented here is to help you to be aware of the common concerns to be considered and to begin the conversation with your CPA tax accountant and attorney.
Bess Kane, CPA