Legal Question in Business Law in California

Re: California conversion from LLC to S-corp

Your corporation would also be subject to an $800 per year franchise tax.

There are provisions in the Corporations Code for converting an LLC to a corporation. See sections 17540.1 to 17540.9. An LLC can also be merged into a corporation newly created for that purpose. Neither process will relieve the disappearing LLC from franchise tax liability it already has incurred.

Let me ask, how could you have NOT known about the franchise tax on LLCs and corporations? It is so fundamental that it makes one wonder if you have sufficient general business knowledge to run an LLC or corporation, for that matter. There are no doubt many other aspects of business operating knowledge that you lack that will get you into trouble down the pike. I'd recommend getting a basic book about small business startup and management in California. There are several of them; the Nolo Press books have been around a long time, are frequently revised, and probably among the best. Check them out.

Another common misunderstanding among people without business experience or training is that an "S" corporation is a special kind of corporation. It isn't. An "S" corporation is like any other for-profit corporation, formed in the exact same way. It becomes an "S" corporation after it is formed, by filing an IRS Form 2553 with the IRS, expressing the unanimous desire of the corporation's shareholders that the corporation be taxed in a certain way. It is not a kind of corporation; it is a corporation that has made a certain election.

The choice to be an LLC or a corporation is much more fundamental; these are different kinds of entities and subject, in large measure, to different laws. One similarity is that both pay $800 a year minimum franchise tax. A difference is that an LLC also pays a percentage of its gross revenue above a certain minimum as an additional tax (I think it kicks in at $250,000 a year, but I'd need to look it up).

There are many factors in the decision whether to use an LLC or a corporation that will elect "S" tax treatment. A factor sometimes favoring the LLC is that its owners can take certain income tax deductions in excess of their at-risk investment basis. This favors LLCs in certain farming, real-estate development and research ventures, which may have large up-from losses before they are profitable. On the other hand, LLCs would be disfavored in large-sales-volume, low margin retailing operations because of the extra tax on gross revenues.