With some frequency a potential buyer will ask if he should form a legal entity with which to operate the business once the purchase is finalized. The answer is generally yes when issues of liability and tax are considered. As liability is a question of law I will always suggest that an individual who wants to explore that subject confer with their attorney. However, I am always happy to talk to issues of tax.
There are positive and negative factors to operating in each form of business, but a few things in my mind are critical:
An LLC is essentially a partnership and a "flow through entity". The earnings of the entity are going to pass through to the members and be subject to both income tax and ( generally) self-employment tax. The self-employment tax is 15.3%, which represents both sides of the SSA and Medicare tax paid on wages in a salary man situation.
But wait there is more (love those statements in ads):
For all California source income the LLC will be charged a fee based upon income (sales) which ranges from a low of $900 to a high of $11,790 depending on the revenues of the business.
If you are planning to purchase real estate, have non resident aliens as investors, or plan uneven distribution of profits a case can be made for the LLC. Also professional service providers will often establish themselves in the LLC structure for reasons that need not be explored here.
The S corporation (also a Flow Through Entity) is more formal in it's structure and can have up to 100 shareholders, all of whom have to be US citizens or residents. Estates and certain trusts can be shareholders. It is critical that all distributions (but not wages) reflect the pro rata shareholder interests in the corporation.
However, if the shareholder operating the business is paid a "reasonable salary" the remainder of the profits are not subject to the self employment tax and a substantial tax saving can be achieved. The tax code does not define "reasonable salary" and the argument with IRS is always challenging. There are no additional fees paid to California in this type of entity, although they do assess a tax of 1.5% of net taxable income.
Do not put real estate into an S corporation.
The above is a simple analysis of the issues and should not be considered either exhaustive or formal. It is possible for an LLC to file income taxes as an S corporation but there are complex rules to this strategy.
The tax code is complicated and each individuals situation different. This requires that you consult with your own legal and tax advisors.