Is a C Corp or S Corp a Close Corporation? The Hidden Truth California Owners Need for 2026

Most California business owners assume a “Close Corporation,” a “C Corp,” and an “S Corp” are interchangeable labels. The reality? Mixing these terms can cost you tens of thousands in taxes, create liability gaps, and attract IRS scrutiny you didn’t bargain for. Here’s the untold truth about how these entity structures work, who qualifies as a close corporation, and which lane actually saves the most money in 2026.

Quick Answer: Are S Corps or C Corps Considered Close Corporations?

Close corporations are a unique legal status available to certain corporations—either C Corps or S Corps—usually selected by small, tightly held businesses. The term determines how the company is governed and operated, not how it’s taxed. So, an S Corp or C Corp can be a close corporation if it files the right paperwork in California. But close corporation status is separate from S Corp (tax) or C Corp (tax) designation. Each status comes with different compliance rules, shareholder restrictions, and tax consequences that affect your wallet in 2026 and beyond.

How S Corps, C Corps, and Close Corporations Really Differ in California

Confusion over corporate types is rampant. Let’s break down the main differences:

• C Corporation: Standard corporation taxed separately from its owners. Faces double taxation: once at the corporate level (federal and CA corporate tax rates), then again on dividends paid to shareholders. Unlimited number of shareholders, plus flexible ownership (U.S. and foreign, individuals and entities).
• S Corporation: Elects pass-through taxation with the IRS (see IRS S Corporation guidance). Profits/losses flow straight to shareholders. No corporate-level federal tax, but you still pay CA S Corp tax (1.5% of net income). Shareholder limits: 100 max, all must be U.S. citizens/residents, no corporations or partnerships as owners.
• Close Corporation: Any C or S corporation that chooses to restrict transfer of stock, limit shareholder number (35 in CA), and operate more like a partnership/family business. Elected via Articles of Incorporation in California (CA Secretary of State Close Corp tips).

If you’re an LLC owner or thinking about electing S Corp status, you need to know whether close corporation status makes sense. Many business owners get caught in compliance traps when legal and tax classifications don’t match.

KDA Case Study: Professional Services Firm Avoids a $33,200 Tax Trap by Understanding Close Corporation Rules

In early 2025, “Ryan,” a San Diego-based engineering consultant, operated as a standard California C Corp with three co-founders. They mistakenly believed C Corp status alone protected their closely held ownership arrangement and kept their income pass-through for state taxes. Here’s what went wrong—and got fixed with KDA:

• Problem: The firm was not designated as a close corporation, so transfer and buyout terms were undefined. A shareholder divorce instantly put 30% of equity at risk, and double taxation (21% federal, 8.84% CA) kicked in on retained earnings for the year.
• Strategy: KDA re-filed Articles of Incorporation as a close corporation, capping share transfers, and prepared a proper S Corp election with IRS Form 2553. We implemented a $110,000/yr comp plan, balancing reasonable salary for founders and minimizing payroll/self-employment taxes (per IRS Publication 535).
• Result: In 2025, Ryan’s team avoided $33,200 in penalty taxes, paid themselves $34,000 more in legal distributions, and locked in succession terms that protected the firm from internal loss. Their $5,800 KDA fee delivered a 5.7x first-year ROI.

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 California Founders Get “Close Corporation” Status Wrong

Here’s the core mistake: business owners confuse the tax status of an S Corp or C Corp with the corporate governance rules of a close corporation. Close corporation status is NOT a tax classification — it’s a legal structure you elect with the state. Common traps:

• Assuming “close corporation” status always saves on taxes (it doesn’t — what matters most is your S vs C Corp election)
• Failing to file close corporation Articles, so stock ownership becomes a legal liability during sales, divorces, or death
• Not updating the S Corp election after converting to or from a close corporation, leading to accidental double taxation

Strategic entity setup, plus the right entity formation services, prevent these risks and set up the right operating and tax environment.

Pro Tip: Use Close Corporation Status for Family or Tight Partnerships—But Mind IRS Traps

If your business involves family members, trusted partners, or you’d rather handle company affairs without outside investors, close corporation status can help. Here’s how:

• It restricts share transfer—so no hostile buyouts, divorces, or lawsuits suddenly shift control
• Keeps total shareholders under 35 (CA law)—which is also required for certain S Corp elections
• Allows for shareholder agreements that limit deadlock or external influence

But beware: close corporation status, on its own, doesn’t shield you from IRS rules on reasonable salary, S Corp shareholder limits, or state franchise tax filings. You still must:

• File S Corp election (if you want pass-through taxation)
• Comply with CA’s $800 franchise tax minimum (see FTB close corp rules)
• Maintain proper corporate minutes and annual filings

What the IRS Won’t Tell You About Mixing Close Corporation Status and S/C Corp Elections

The IRS doesn’t track or enforce close corporation status—it’s enforced at the state level (California Secretary of State). But if you think electing S Corp tax treatment protects you from close corporation legal gaps, think again.

• If your business exceeds the close corporation shareholder limit, you jeopardize both S Corp and close corp status.
• Messy transfers, disputes, or un-documented agreements can violate S Corp eligibility—disqualifying your pass-through status and triggering retroactive double tax at the C Corp level.
• Improper recordkeeping can forfeit close corporation protection entirely, exposing your assets.

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

Step-by-Step: How to Elect Close Corporation and S Corp/C Corp Status in California

1. File Articles of Incorporation as a Close Corporation. Use Form ARTS-CL from the California Secretary of State. List “close corporation” as type, include shareholder limits (35 max), and spell out transfer restrictions.
2. Adopt a Shareholder Agreement. This agreement governs management, voting, transfer rules, and dispute resolution. Update annually.
3. Determine your tax election:
   • If you’re a C Corp, default status is double-taxed (profits at corporate and dividend level), but you can remain a close corp legally.
   • If you want S Corp pass-through, file IRS Form 2553 within 75 days of incorporation or the start of the tax year.
   • All shareholders must consent and meet IRS criteria: individuals, estates, single-member trusts, U.S. citizens/residents only.
4. Maintain annual requirements. File CA Franchise Tax returns (Form 100S for S Corps, 100 for C Corps), hold annual meetings, and keep minutes.
5. Ensure compliance on all changes. Admitting new shareholders, converting status, or selling shares may require CA Secretary of State filings and potential S Corp re-election with the IRS.

Red Flag Alert: Penalties and Horror Stories from Mismanaged Close Corporation Elections

Consequences of getting this wrong are real and brutal in 2026:

• Lose S Corp status due to ineligible shareholder or breaching the 100-owner limit—IRS will retroactively tax all profits as a C Corp (double taxation, interest, and penalties, sometimes $50K+).
• Transfer or succession mistakes—if you fail to update shareholder agreements, a departing shareholder’s interest could transfer to an ineligible entity (like an LLC or another C Corp), invalidating S Corp election.
• Lawsuits during buyouts/divorces due to missing close corporation restrictions—can wipe out control and cost you $100K+ in legal fees, lost value, or misallocated corporate profits.

Key Takeaway: In California, the legal structure (close corporation) and tax status (S Corp or C Corp) are two different elections—and both must be managed intentionally to protect your profit, control, and audit risk in 2026.

Will This Trigger an Audit? Top FAQ

What exactly makes a corporation a “close corporation” in California?

In California, a close corporation is one that restricts stock transfers (by law), limits ownership to 35 shareholders, files close corp Articles, and usually is operated as a partnership or family-run company. Legal requirements are state-mandated, not IRS.

Is close corporation status a tax election?

No. Tax status (S vs C) is chosen through the IRS. Close corporation status only changes legal governance and operations, not tax classification, but can impact S Corp eligibility.

What if I already run an S Corp—should I elect close corporation status?

If you have a small, private company with a handful of shareholders, it often adds protection against unwanted takeovers or disputes. But get clear legal/CPA advice first—errors can limit funding or future flexibility.

How does my choice affect the $800 CA franchise tax?

Close corporations pay the same franchise tax rates as other S Corps or C Corps. There’s no special tax break for being a close corporation alone.

Do I need a special CPA or attorney to file?

It’s highly recommended. Errors made during entity structuring, Articles amendments, or tax election can be seen as negligence by the IRS, opening up audit or penalty risk.

How to Decide: Should You Elect S Corp, C Corp, or Close Corporation?

Here’s a decision map for California founders in 2026:

Factor	C Corp	S Corp	Close Corporation
Taxation	Double (21%+8.84%+ dividends)	Pass-through, 1.5% CA	Depends on S/C election
Shareholder Limit	Unlimited	100, must be individuals/US only	35 CA max (stricter)
Corporate Formality	High	High	Flexible/partnership style
Ease of Funding	Easiest (VC/IPO)	Limited (no foreigns/entities)	Hardest (private/family only)
Legal Liability	Strong protection	Strong protection	Strengthened with shareholder agreement

What If My Entity Structure Needs to Change?

If you’re currently a C Corp or S Corp and want close corporation status, you must file Amended Articles, update shareholder agreements, and—for S Corps—file IRS Form 2553 if changing from C to S tax status. If moving backwards (close corporation removing restrictions), file conversion paperwork and re-select your tax election as needed. For step-by-step support, see our entity formation services.

Pro Tip: Use a Small Business Tax Calculator for Scenario Analysis

If you want to see tax outcomes of C Corp vs S Corp vs pass-through, plug your projected profits into this small business tax calculator and model distributions, payroll, and dividend tax hits for California owners.

This information is current as of 2/13/2026. Tax laws change frequently. Verify updates with the IRS or FTB if reading this later.

Your Next Step: Book a Tax Strategy Session If You’re Unsure

If you’re not 100% certain your business entity setup is optimal—especially if you’re worried about IRS audit triggers, California compliance, or succession planning risk—get personalized advice. Book a strategy session with KDA and walk away with a blueprint built for YOUR scenario, with savings/penalty avoidance worth $10,000+ in most client situations. Click here to book your consultation now.