Why Believing Sub S Corp and C Corp Are Taxed the Same Is Costing California Owners Thousands
Ask five California business owners if Sub S Corps and C Corps are taxed the same and at least three will say “Yes—they’re both corporations.” That misconception is the difference between taking home what you’ve earned and bleeding out tens of thousands a year. In this post, you’ll get a line-by-line breakdown (something you won’t find on basic Google guides) of how tax liabilities diverge the moment you file a Sub S election or stick with C Corp status, complete with real numbers, IRS rules, and KDA case study proof.
Quick Answer: Sub S Corps and C Corps are fundamentally taxed differently, creating massive swings in total tax paid, net owner income, and risk exposure. Most owners only learn this after an audit or an expensive accountant call. Here, we’ll make it unmistakably clear.
How the Federal Tax Code Splits S Corps and C Corps in 2025
The federal government treats S Corps and C Corps as entirely different entities for tax purposes, despite them sharing “corporation” in name. Under IRS rules, a C Corp (the default form) pays tax as its own entity at a flat 21% rate (IRS C Corporation guidance). Profits paid to shareholders as dividends are taxed again at the individual’s dividend rate—typically 15–23.8%.
By contrast, an S Corporation (popularly called a “Sub S Corp”) does not pay corporate income tax. Instead, all profits and losses “pass through” to shareholders, who report them on personal returns and pay tax at their own bracket. This alignment immediately sets up two entirely different tax outcomes—even before you factor in FTB rules for California owners.
- C Corp double-taxation: $250,000 in profit nets just $165,325 to the owner after both levels of tax (estimate for high-income group).
- S Corp single-taxation: That same $250,000 passes to owners with just the personal rate, skipping a second round of tax on dividends. Bottom line? More cash, every year.
If you’re a business owner (LLC or Inc.) evaluating the best tax setup, you need a custom plan—not the default structure recommended at most bank branch openings. See how we break this down for serious business owners.
S Corp Payroll: Where Owners Pocket an Extra $19,500 a Year
The most misunderstood advantage of a Sub S Corp is the ability to pay owner-employees a salary—then distribute excess profits as “dividends” exempt from self-employment tax. Here’s a real-world scenario:
- 1099 consultant reports $160,000 net profit as sole proprietor (Schedule C): Pays income tax plus 15.3% self-employment tax on all earnings.
- S Corp owner pays self $80,000 salary (W-2), reports the remaining $80,000 as S Corp distribution: Only the W-2 salary portion is subject to payroll tax; the $80,000 distribution is exempt from self-employment tax.
This strategy alone saves $12,240 a year, every year, when compared to the same income run through a C Corp dividend scenario or a pure Schedule C.
Strategic use of payroll and distributions is central to our bookkeeping and payroll planning services. We see S Corp owners routinely keep $15K–$24K more after-tax with a fully optimized salary/dividend split. (See IRS S Corporation definition.)
For a full breakdown, see our comprehensive S Corp tax guide including California state add-ons, franchise fees, and audit proofing.
KDA Case Study: Solo LLC Owner Recovers $13,700 After S Corp Switch
“Jennifer,” a solo California LLC owner and digital marketer, consistently reported $180,000–$220,000 net in her single-member LLC (default Schedule C). She was paying nearly $55,000+ per year in self-employment and income taxes—even with her accountant “finding all the possible write-offs.”
After a KDA strategy session, we converted her to a Sub S Corp, reclassified her income, and implemented a $98,000 reasonable salary with the rest as distributions. Her first-year tax savings exceeded $13,700—and her audit risk actually dropped with clean payroll records. She paid $3,500 for the entire setup, delivering a 3.9x ROI in year one alone. Each subsequent year, that annual savings simply continues. (KDA is still her tax strategist today.)
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.
Why Most Owners Botch the California State Tax Math
The state of California does not treat S Corps and C Corps identically. While C Corps pay the minimum $800 Franchise Tax plus 8.84% of California taxable income, S Corps pay the $800 minimum plus 1.5% of net income—but the profit passes to your individual return and is taxed at your personal rate. Too many owners stick with a C Corp expecting “protection” only to be smacked with double taxation on state and federal returns.
Myth busted: S Corps do not escape the $800 minimum Franchise Tax, and must file FTB Form 100S in California. But the pass-through structure often results in 10–25% net after-tax savings compared to a C Corp paying out the same profit as dividends. This is why S Corp strategy is core for modern LLC/Inc. owners in California.
Many LLC owners also assume they can skip payroll or the S Corp franchise tax by just “waiting until year-end.” Wrong: Both entities have firm due dates and penalties if you miss these. For complex returns, professional tax preparation and filing are the most reliable defense against FTB and IRS headaches.
Common Tax Traps When Mixing S Corp and C Corp Strategies
This is where most business owners who “heard from a friend” fall. Here are 3 tax traps that cause trouble in 2025:
- Trying to have it both ways: Failing to make or properly document S Corp election with the IRS (via Form 2553) leaves your business taxed as a C Corp by default—even if your CPA says otherwise. Miss this, and you’re in for double taxation. IRS Form 2553 info.
- Paying “dividends” to S Corp owners: They must be classified as distributions, not dividends. Reporting them inaccurately can trigger IRS audits and penalties on payroll or reclassification. Pro Tip: Always use W-2 payroll for S Corp owners’ active compensation and retain clean records.
- Mixing personal and business expenses: Either entity structure is vulnerable if you blend owner draws, distributions, or reimbursements without strict business record-keeping.
Audit tip: Both S Corps and C Corps face increased IRS scrutiny in 2025, especially in California, according to expanded audits cited in recent IRS news releases.
Pro Tip: Use IRS Tools—But Don’t Stop There
If you want to run actual numbers, start with a small business tax calculator to estimate overall tax impact. But real savings happen when you tailor strategy to your specific income, owner structure, and state rules. Never assume a default setup is best for your scenario. For an in-depth analysis, see our premium tax advisory services that routinely generate double-digit ROI for new clients switching entity types.
What If You Already Filed the Wrong Entity? Can You Change?
Yes—and this is one of the biggest missed opportunities for heads-down business owners. The IRS allows C Corps and LLCs to elect S Corp status by filing Form 2553, even retroactively in many cases (if acting within the deadline). California’s FTB accepts late elections under specific circumstances as well, though penalties can apply. If your tax liabilities were excessive in prior years, it’s often possible (and worth it!) to amend or switch.
Important: Always coordinate any status change with a CPA experienced in both federal and CA state tax law. Many DIY providers overlook CA FTB nuances, resulting in revoked S Corp status or rejected filings.
FAQs: Sub S Corp vs C Corp Taxation Differences in Practice
How does owner compensation work in S Corps versus C Corps?
In S Corps, owners who actively work in the business must be paid a “reasonable salary” via payroll, then receive distributions. C Corp owners can take salary or dividends, but dividends face double taxation: first at entity level, then at personal rate.
Can California S Corps avoid the state’s $800 minimum tax?
No. Both S Corps and C Corps must pay the $800 annual minimum Franchise Tax. S Corps also pay 1.5% of net income, while C Corps pay 8.84%—plus, remember, double federal taxation applies for C Corps. See California Franchise Tax Board for updated forms and fee schedules.
Is a single-member LLC ever better than an S Corp?
Sometimes—at very low profit levels (under $40,000/year), the additional payroll and compliance costs may outweigh S Corp savings. But above that, S Corp typically wins for take-home unless you plan to sell the business or attract investors.
Red Flag Alert: Underestimating Audit Risk When Changing Structures
Many owners think switching to an S Corp is a silver bullet for tax savings, but forget the IRS closely audits S Corp “reasonable salary” calculations, especially in California. Always document the basis for salary, keep board minutes, and use third-party compensation data if possible for audit defense. According to IRS Publication 535, failing to pay a reasonable salary may result in all distributions being recharacterized as wages, with back payroll tax, penalties, and interest.
Bottom Line: S Corps and C Corps Are Not Taxed the Same—And the Difference Is Your Take-Home Pay
The entire point of entity structure is to keep more of what you earn. Sub S Corps and C Corps were built for completely different types of taxpayers and different outcomes. Believing they’re taxed the same isn’t just an oversight—it’s a six-figure mistake over a decade. Our clients routinely increase after-tax income by 10–23% simply by choosing and executing the optimal structure and then backing it up with correct payroll, distributions, and compliance..
This information is current as of 12/26/2025. Tax laws change frequently. Verify updates with the IRS or FTB if reading this later.
Book Your S Corp or C Corp Tax Savings Session
If you’re not sure if your corporation type is quietly costing you thousands, that’s your signal to get expert strategy. Book a KDA consultation and we’ll map out your best post-tax gameplan, plus fix any past setup errors before they cost you more. Click here to book your tax savings consultation now.
