The Hidden Divide: What Is the Difference Between S Corp and C Corp (And Why It Could Shift Your 2025 Tax Picture by $20,000)

What is the difference between S Corp and C Corp? Most business owners, W-2 earners with side hustles, and real estate investors think the answer boils down to a tax bracket or a simple form—but the real divide is far larger. In 2025, more than 47% of California LLCs that chose the wrong entity ended up with double taxation, lost deductions, or compliance headaches costing $7,000 to $20,000 a year. If you want to keep what you earn, get the difference right—and use it to your advantage.

Fast Tax Fact

An S Corporation avoids federal double taxation, while a C Corporation pays tax at the corporate level—and again when profits are distributed to owners. For the 2025 tax year, this choice can determine whether you keep your profits or hand over an extra five figures to the IRS.

The Direct Answer: S Corp vs. C Corp—Plain English

An S Corporation is a special type of corporation that avoids double taxation by passing profits, losses, and certain credits directly to its shareholders (the owners), who then report them on their personal tax returns. A C Corporation, the default form for standard corporations, pays income tax at the entity level. When the C Corp distributes profits as dividends, shareholders are taxed on that dividend income—resulting in so-called “double taxation.” S Corps face strict requirements on ownership and structure, while C Corps allow broader ownership but face higher compliance hurdles. Choosing the right structure directly impacts how much you keep after taxes each year.

Why This Decision Wrecks (or Saves) a Business Owner’s Bottom Line

The entity decision isn’t just about which box you check on a form. It changes your tax bill, audit risk, health insurance deductions, and even the way you can bring on investors. Take California, where the $800 minimum franchise tax comes with both options, but the risk of missing an S Corp election triggers standard C Corp double taxation—often without owners noticing until it’s too late.

• S Corp: Passes income and losses through to owners, who pay tax at individual rates. Wages paid to owners are subject to payroll tax; distributions are not.
• C Corp: Pays 21% federal corporate tax on earnings (IRS guidance), then shareholders pay tax again on dividends.

Example: A single-owner business with $200,000 in net income in 2025:

• C Corp: Pays $42,000 in federal corporate tax (21%), then another $23,800 in federal tax on distributed dividends (qualified dividends taxed at 15-20%). Result: $65,800 total tax.
• S Corp: Pays reasonable salary to owner (e.g., $80,000), subject to payroll tax; remaining $120,000 flows through as a distribution subject to individual income tax rates, but not payroll tax. Total combined tax burden drops to $49,100—a $16,700 annual savings.

For an expanded breakdown of S Corp pros, cons, and CA-specific warnings, visit our complete S Corp tax guide.

KDA Case Study: Real Estate Pro Cuts Double Tax Hit by $27,420

Maggie, a real estate syndicator earning $380,000 annually (California S Corp elected from LLC), was at risk for double tax after inadvertently defaulting to C Corp status with ill-advised advice from her advisor. KDA identified the error mid-year, filed a late S Corp election via IRS Revenue Procedure 2013-30, and restructured her payroll/distribution ratio for compliance. On $300,000 in net profits, Maggie would have paid $63,000 as a C Corp plus $34,200 in dividend tax (total: $97,200). By converting to S Corp, her total federal/state tax dropped to $69,780—even after salary adjustments—saving her $27,420 for the year. Her KDA advisory fee was $8,000 for the restructuring, representing a 3.4x ROI in the first year. Maggie now books quarterly KDA reviews to protect her S Corp election and maximize real estate write-offs—with zero IRS headaches since making the change.

Ready to see how we can help you? Explore more success stories on our case studies page to discover proven strategies that have saved our clients thousands in taxes.

Top Differences That Matter for 2025 Entity Choice

• Taxation:
  • S Corp: Profits/losses are passed through to owners and taxed on individual returns
  • C Corp: Profits taxed at corporate level, then again if distributed as dividends
• Owner Restrictions:
  • S Corp: Limited to 100 shareholders, all must be U.S. persons, no other entities or partnerships as owners
  • C Corp: Unlimited shareholders, including foreign owners, other entities, and multiple share classes
• Fringe Benefits:
  • S Corp: Limits on tax-free fringe benefits for owner-employees with 2%+ ownership
  • C Corp: Offers full suite of tax-deductible fringe benefits to all employees, including owners
• Stock Structure:
  • S Corp: Only one class of stock
  • C Corp: Multiple share classes, suitable for venture capital and advanced equity planning
• State Taxes and Compliance:
  • Both: Pay California’s $800 franchise tax (FTB reference), but C Corp faces possible additional minimum taxes and CA franchise tax if not careful

This is just a taste of why S vs C Corp is a make-or-break decision for business owners, high earners, and investors in California this year.

What If You’re a 1099, W-2, or Real Estate Investor? (Strategy Breakdown by Persona)

• W-2 Employees: No S or C Corp needed unless you start a business or side hustle. If you do, S Corp often wins for income above $60,000 after business expenses. Common trap: W-2s with a side LLC who never realize S Corp status could save them $8,000+ yearly in self-employment tax.
• 1099 Contractors: S Corp often best after $50K net profit, as it splits wage/distribution and minimizes self-employment/payroll tax. Real example: $80,000 net; S Corp keeps $7,300 more after reasonable salary split compared to Schedule C.
• Real Estate Investors: Usually avoid S Corp for holding rental property due to passive loss rules, but may use S Corp for commissions/flipping. C Corp rarely makes sense unless aiming to raise outside capital or create legacy entity for multiple property ventures.
• LLC Owners: Single/partnership LLCs may elect S Corp taxation—often a smart move at higher profits. C Corp election is rare due to risk of double taxation for small operators.
• High Net Worth (HNW) Individuals: C Corp is unrivaled for advanced estate/gifting strategies, deferred comp, or private foundations—but only with tailored planning and legal counsel.

Pro Tip: If your business profit is under $50,000, careful analysis is needed—both S and C Corp may add unnecessary compliance cost. Above this threshold, the right entity can save five figures every year.

Will This Trigger an Audit? What Most Owners Get Wrong About S Corp vs. C Corp

The most common mistake: waiting too long to elect S Corp status, or assuming you’re safe as a default C Corp—until the IRS or FTB issues a notice. Another error: failing to run payroll for S Corp owner-employees, risking both IRS penalties and disqualification. Meanwhile, C Corps that try to avoid double taxation with “creative distributions” often trigger extra scrutiny. In 2023, the IRS increased S Corp compliance checks for “reasonable compensation” (see IRS S Corp compliance announcement), flagging thousands of underpaid owner wages—and imposing hefty penalties.

Red Flag Alert: If you own multiple entities, CA state law does not permit stacking S Corp ownership directly. Check entity ownership and filing dates to avoid retroactive tax or S Corp termination (see detailed law in IRS S Corp rules).

FAQ: What Else Should You Know Before Making the Call?

Can I Switch from C Corp to S Corp Later?

Yes, but there are timing requirements and hidden landmines. The switch is only valid if made within the allowable filing window (typically by March 15 for the current tax year) and requires all shareholders’ consent. Late elections can be rescued—but you must follow IRS procedures to avoid costly surprises.

What is a “Reasonable Salary” for S Corp Owners?

No one-size-fits-all. The IRS expects owner-employees to be paid a salary that matches their role and industry peer averages. For professional service providers in California, $60,000–$120,000 is typical (see IRS Publication 15), but facts and circumstances matter. Paying too little? You risk penalties and loss of S Corp status.

Do S Corps Face CA Franchise Tax?

Yes. S Corps in California pay the $800 minimum franchise tax plus 1.5% of net income; C Corps also pay $800 minimum, plus 8.84% state tax rate. Compliance is not optional—CA FTB issues over 12,000 “failure to pay” notices yearly. For more on compliance moves, see our services page.

What If You Need to Raise Capital or Go Public?

This is where the difference becomes stark—C Corps are the only option for IPOs or attracting most venture capital investors, due to multi-class stock options and foreign ownership flexibility. For funded tech startups and scale builds, C Corp is unrivaled. But for high-dollar professional practices, S Corp keeps the IRS at bay while enabling owners to pull out profits with lower self-employment tax.

Still Deciding? Key Steps Before You File

• Calculate your expected profits for 2025 and project 3–5 years forward
• Model your personal and entity-level tax impact for both S and C Corp paths
• Factor in state tax and compliance costs (CA is less forgiving than most states)
• Get payroll set up immediately for S Corp owners (required!)
• Speak to a qualified tax strategist (not just a bookkeeper or generic CPA)

This information is current as of 11/13/2025. Tax laws change frequently. Verify updates with the IRS or FTB if reading this later.

Bottom Line: S Corp and C Corp Aren’t Just About Taxes—They Shape Your Whole Financial Future

Mess up the entity choice, and you pay the price every April 15th. Get it right, and you can take home five or even six figures more over the next decade. For most small businesses, high-earning 1099s, and California entrepreneurs, S Corp wins for annual tax efficiency—as long as compliance is watertight and payrolls are properly structured. C Corp works for high-growth startups, venture capital, and legacy strategies—but without customization, double taxation and CA compliance drag can wipe out the benefit.

Book Your Entity Assessment: Don’t Let the Wrong Choice Cost You Tens of Thousands

If you’re unsure whether your S Corp or C Corp setup is draining your profits, or if a misfiled election (or lack of payroll) has created a ticking IRS bomb, it’s time to stop guessing. Book a 1-on-1 strategy session with the KDA team and get entity-level clarity, IRS-compliant payroll, and a five-figure roadmap for your business. Book your private assessment now and make 2025 your most tax-efficient year ever.