Types of Entity: LLC, C-Corp, S-Corp — The Decision That Defines Your Tax Bill (and Audit Risk) for Years

Most business owners will lose five figures or more by picking the wrong entity — and worse, the IRS will never warn you about it. If you’re considering launching a new business or restructuring what you’ve built, the stakes on entity choice have never been higher. Misclassify your business, and you may be stuck with a tax structure that quietly drains up to 38 percent of your profits each year or puts a target on your back for state and federal audits. The good news: If you know the difference between the main types of entity — LLC, C-Corp, S-Corp — you can tilt the rules in your favor and lock in tax savings starting this year.

Choosing between the types of entity llc c-corp s-corp is not a legal preference—it’s a tax engineering decision. Each structure controls how income is taxed (ordinary vs. payroll vs. dividend), when it’s taxed, and who pays first (you or the entity). The IRS doesn’t optimize this for you; it simply enforces whatever structure you chose. Smart owners model payroll tax, QBI eligibility, and exit tax before locking in an entity.

For the 2025 tax year, California’s legal and tax landscape is changing fast. This guide cuts through the confusion to show entrepreneurs, freelancers, real estate investors, and high earners exactly where to win (and where you will lose) by entity type — and how the right move can yield savings of $12,000, $33,700, or up to $107,000 per year, depending on your income and strategy. Types of entity like LLC, C-Corp, and S-Corp structure everything from tax reporting to audit odds, liability, deductions, and compliance headaches. Which is right for you? Let’s break down the facts, myths, and real savings.

Quick Answer: LLC, C-Corp, S-Corp — What’s the Real Difference?

At a high level, here’s how entity choice shapes your finances:

• LLC: Flexible, protection for your assets, flows income to you personally. Simpler to manage, but sometimes leaves tax savings on the table, especially for 6-figure earners.
• C-Corp: Best for startups seeking outside investment or planning for an IPO. Lower federal rates (21%, post-2017), but faces double-taxation — once at the corporate level, again when dividends are paid to you. Hard to unwind if plans change.
• S-Corp: Bridges the gap. Blocks double taxation, lets you split income between salary (payroll taxes) and distributions (no payroll tax owed), but strict IRS requirements and California compliance adds complexity. Biggest average savings for profitable service businesses ($100K+ net income).

Bottom line: Entity choice is a tool, not just paperwork. Choosing a type for the wrong reasons can cost more than taxes — it impacts audit risk and how much of your business you truly own in five years. You need to fit the entity to your actual income, future plans, and personal tax situation.

LLC: Flexibility, Simplicity — But Watch the California Tax Trap

An LLC (Limited Liability Company) is the starting point for many solo-preneurs and family partnerships. With just a few forms, you can have professional liability protection, pass-through taxation, and skip the internal formalities of a C-Corp. But too many LLC owners think the job is done after setup. Here’s where the real tradeoffs show up:

• California LLCs pay an $800 annual Franchise Tax — even if there are no profits. If revenue passes $250,000, gross receipts fees kick in (ranging from $900 to $11,790 extra per year). See Franchise Tax Board rules for details.
• LLC profits flow directly to owner’s personal tax return (Schedule C for solo owners, or K-1 for partnerships/multi-member LLCs). For high-earning professionals ($150K+), this can mean 37%+ marginal tax rate — higher Medicare/Social Security costs versus S-Corp election.
• Protection is strong — but LLCs don’t eliminate liability from personal mistakes, fraud, or failure to keep business/personal funds separate.

Why choose an LLC over other types of entity? For freelancers, real estate investors, or small family businesses with modest profits ($50K or less), simplicity outweighs the California fee load. But once profits rise past $100K, the payroll tax hit becomes painful.

If you’re an LLC owner considering an S Corp election, understanding the salary and compliance requirements is critical. Many business owners miss this detail and face penalties later.

KDA Case Study: S Corp Pivot Unlocks Five-Figure Savings for Engineering Consultant

Meet “Eric,” an engineering consultant in Orange County. He started as a solo-member California LLC, billing $200K a year, and paid himself everything as owner draws. But by year three, his self-employment tax hit $29,150, and the Franchise Tax Board mailed a compliance warning due to missed gross receipts fees. KDA examined Eric’s books, ran a tax forecast, and recommended S Corp election mid-year. We set up compliant W-2 payroll (reasonable salary: $85,000), split the rest as S Corp distributions, and reclassified deductions for health insurance and retirement. First-year savings: $16,300 (mainly Social Security/Medicare and state fees). Eric paid $3,400 for the strategic restructure, but saw nearly a 5x ROI in 12 months.

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.

C-Corp: When Double Taxation Makes Sense — and When It’s a Disaster

The C-Corporation (C-Corp) is the historic favorite for big businesses, venture-backed startups, and companies planning to go public. But for small business owners, a C-Corp can easily become a trap rather than a ticket to wealth. Here’s why:

• Taxation: C-Corps pay a flat 21% federal income tax (since the Tax Cuts and Jobs Act). But every dollar you take out as a dividend is taxed again at the individual level (up to 20% federal + 3.8% NIIT + California income tax up to 13.3%).
• Deductions: Broader for large-scale benefits (health insurance, fringe benefits), but most main street businesses rarely use these fully.
• Paperwork: More accounting, double filing, and mandatory board/shareholder meetings. If you want simplicity, C-Corp is not it.
• California Headache: Still on the hook for $800 franchise tax, state corporate filing fees, and possible apportionment if operating outside California.

When is a C-Corp worth it? For businesses raising venture capital or holding earnings for reinvestment (R&D, large equipment buying), the math can work — especially if you qualify for the small business stock exclusion (Section 1202). But most service professionals, consultants, or investor-owned businesses will pay more tax overall than with an S Corp or LLC structure.

Strategic entity structuring is complex. Our entity formation services help you assess the right type, file compliance paperwork, and navigate franchise tax traps.

S Corp: California’s Most Misunderstood Tax Secret for High Earners

The S Corporation (S-Corp) is the “Goldilocks” entity for many solo and small business owners. The legendary draw: pay yourself a reasonable salary (with payroll taxes), then take the rest of your profits as distributions — skipping Social Security and Medicare taxes on that portion.

• Tax Savings Example (2025 law): If you’re netting $180,000/year as a consultant, pay yourself $90,000 as W-2 salary (paying payroll taxes on only half your profit), and take the other $90,000 as S Corp distributions — saving you $13,770/year in payroll taxes alone.
• Compliance Hurdles: S Corps must file IRS Form 2553, keep impeccable books, run actual payroll, and stay under 100 shareholders (all must be U.S. citizens/residents, see Form 2553 guidance).
• California S Corp Franchise Fee: $800 minimum plus 1.5% of net income — not pocket change, but often outweighed by payroll tax savings for profitable businesses.
• Entity traps: One foreign shareholder, missed payroll, or unreported distributions, and you could lose Subchapter S status — and revert to C Corp status with double-tax.

For a complete breakdown of S Corp strategies, see our comprehensive S Corp tax guide.

Common Audit Traps, IRS Red Flags, and Entity Myths Busted

Hundreds of California filers are flagged every year for misusing LLCs, S Corps, or C Corps — and it’s not just technicalities. Here are three red flags that trigger audits, penalties, and disaster rescues:

• Red Flag #1: S Corp salary set too low relative to industry standards. (The IRS has caught on to “$30K” pay for a $400K net-profit owner — and will reclassify the rest as wages per IRS S Corp compensation guidance).
• Red Flag #2: C Corp not paying dividends but sitting on cash year after year. The IRS can hit you with the accumulated earnings tax if you hoard profits without a valid reason.
• Red Flag #3: LLCs reporting “zero” profits several years running. The FTB or IRS can pierce through the structure if they see evidence of personal benefit without true business activity.

Pro Tip: Always maintain separate bank accounts, run payroll (for S Corp), and document all equity transfers. Never let a bookkeeper or online platform set your entity strategy.

How to Spot the Right Entity for Your Income, Industry, and Exit Goals

Wondering which entity unlocks the most savings, protection, and flexibility for your situation? It comes down to five factors:

• Income Level: Under $80K? LLC may suffice. Over $100K? S Corp usually wins — but only if you will run payroll, keep clean books, and want to optimize yearly tax efficiency.
• Owner Count & Residency: Want outside investors, or have non-US partners? C Corp may be your only viable option. S Corp restricts owners to U.S. citizens/residents with one class of stock.
• Industry Type: Real estate investors often favor LLC or partnership structures for flexibility and asset protection. Tech, biotech, and high-growth startups usually need C Corp for funding.
• Tax Strategy: Is your goal to pass as much cash to yourself now, or to sell the business in 5–10 years? LLCs and S Corps are more flexible for owner draws and distributions.
• Exit Plan: C Corps are best for selling stock or attracting VC funds; S Corps or LLCs are superior for family transfers or asset sales.

If you want to see how your potential salary and draws affect your tax bill, the small business tax calculator can help estimate your bottom line.

What If I Want to Change My Entity Type?

Many taxpayers assume their initial entity choice is permanent. In reality, you may be able to convert — with proper timing:

• LLC to S Corp: File Form 2553 with the IRS (and California) by March 15 of the tax year you want S Corp treatment. Miss the deadline, and relief options exist — if you qualify and act quickly (see IRS Form 2553 late election provisions).
• S Corp to C Corp: File a revocation with the IRS. Important: All undistributed S Corp earnings may be subject to tax in the conversion year — don’t do this without specialized guidance.
• S Corp or C Corp to LLC: Requires legal dissolution/liquidation, transfer of assets, new EIN, and possible recognition of capital gains on assets. Plan for legal and tax bills.

Red Flag Alert: DIY entity changes without tax counsel lead to lost elections, missed deductions, and surprise multi-year back taxes.

FAQs: Picking the Right Entity in 2025

Q: What’s the simplest entity for a new side hustle or consulting business?

A: Single-member LLC. Easiest setup, strong liability shield. But consider S Corp election if profits exceed $100K within first two years.

Q: Can I have multiple businesses under one S Corp?

A: Not directly. Each S Corp is a separate entity. You can operate multiple DBAs under one S Corp, but for true liability protection, consider multiple entities.

Q: Should a real estate investor use an S Corp?

A: Rarely. LLCs and partnerships are usually superior — S Corps complicate step-up in basis and passive loss rules. See IRS Publication 925 for more.

Q: Is C Corp better for deductions?

A: For health/benefits and R&D, yes — but total tax often outweighs extra write-offs for most self-employed. Use C Corp only for companies planning outside capital or going public.

Book Your Strategic Entity Review

If you suspect your business structure is costing you real money — or you want to capture S Corp payroll savings fast — now is the time. Book a 1-on-1 strategy session with our entity experts at KDA, and walk away with a clear, customized game plan before the next tax cycle. Schedule your strategic review here and keep your profits in your own bank account.