Difference Between LLC and S Corp California: The $40,000 Mistake Business Owners Can’t Afford Anymore

Most California entrepreneurs believe choosing between an LLC and an S Corp is just a paperwork issue. In reality, the distinction can mean the difference between hemorrhaging $40,000+ in unnecessary taxes — or keeping that cash in your hands every year. This post uncovers the overlooked tax, compliance, and risk traps hiding inside each business structure — and shows you how the wrong choice echoes for years, not just tax season.

Quick Answer: LLCs give flexibility but can punch high earners with double self-employment tax — think an extra $15,000+ for six-figure solo founders with no W-2 setup. S Corps slash that pain using a legal salary-distribution split, but compliance missteps in California (think $800 minimum tax, strict FTB scrutiny) can eat those savings fast if you’re unprepared.

This information is current as of 10/1/2025. Tax laws change frequently. Verify updates with the IRS or FTB if reading this later.

The Real Tax Difference: What California Owners Actually Pay

The core difference between an LLC and S Corp in California is how the IRS taxes your profits — and the state’s extra layer of fees and compliance. Here’s a street-level breakdown:

• LLCs: Profits are generally taxed as self-employment income. You pay both the employer and employee side of Social Security + Medicare (15.3%).
• S Corps: Profits are split between W-2 salary (subject to payroll taxes) and shareholder distributions (exempt from self-employment tax).

For a California-based solopreneur netting $200,000:

• LLC (default tax): Pays roughly $28,000 in self-employment tax ($200,000 x 14.13% after deduction; see IRS Publication 334), plus state income tax, plus the $800 CA franchise tax.
• S Corp (with $80K “reasonable salary”): Pays payroll taxes only on the $80K salary (about $12,200), rest ($120K) escapes 15.3% self-employment tax, saving ~$18,360 every year.

Featured Snippet Answer: In California, the biggest financial difference between LLC and S Corp is that S Corps let you avoid self-employment tax on distributions, while LLCs tax all profit as self-employed income. In practice, switching to an S Corp can save a typical high-earning business owner $15,000–$25,000 or more each year — but only with proper compliance and payroll setup.

KDA Case Study: California Consultant Doubles Tax Savings With S Corp Election

Profile: Single-member LLC consultant, $230,000 annual net profit, marketing services, Los Angeles.

Problem: After years as a “plain vanilla” LLC, Amy faced $31,400 in self-employment taxes — and rising CA state tax headaches as earnings grew. She worried that S Corp payroll fees and complexity would eat the savings. Her former tax advisor never ran the numbers or explained the audit risks of staying LLC.

KDA’s strategy: We analyzed Amy’s expense categories and recast her LLC as an S Corp before mid-year. We set her “reasonable salary” at $92,000 and ran compliant payroll (including all required filings: Forms 941, 940, DE-9, and Statements of Information). Her remaining profit was paid out as S Corp distributions, avoiding self-employment tax — and we managed the $800 CA minimum tax and FTB filings end-to-end.

Results: Amy slashed her self-employment tax by $18,936 in year one. Her all-inclusive KDA fee? $4,000. Net ROI: 4.7x in real tax cash-back the very first year — with bulletproof records. She’s on pace to save $100K+ over five years, with zero audit anxiety.

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.

California LLCs: Flexibility, Hidden Fees, and When They Make Sense

It’s not all about tax rates. California’s default LLC structure can be a landmine — unless you’re running real estate, holding family assets, or want simplicity over savings. LLCs are taxed as sole proprietorships (or partnerships for multi-member), paying the full 15.3% self-employment tax on every dollar of profit. But for investors or low-activity businesses, this pass-through can be a feature, not a flaw.

California Gotchas:

• $800 Annual Franchise Tax: Applies even if you lose money, per the FTB.
• LLC Fee Tier: 0.75%–1.5% extra if you gross over $250K — separate from income tax.
• 1099 Traps: If you pay contractors in CA, your LLC faces stricter rules (see CA FTB Withholding Requirements).
• Audit Simplicity: LLCs are less scrutinized for payroll and tax shelter abuse compared to S Corps, but easier to “pierce the veil” if you co-mingle funds.

For real estate, family partnerships, or asset holding companies — a plain LLC can make sense. For high-profit active businesses, the taxation is punishing. If you grow or shift to payroll, consider an S Corp election for next year.

S Corp Essentials: Tax Savings, Compliance Burdens, and the California Catch

S Corps are how seasoned California owners extract bigger profits — but they don’t fit all businesses. The IRS lets you split income between “reasonable salary” (subject to payroll taxes) and dividends (which escape them). Business owners earning $120,000+ a year benefit most — if their payroll is set up right and they don’t run afoul of FTB rules.

• Payroll setup required: Must run a legal W-2 salary. If not, you risk S Corp audit penalties.
• $800 CA S Corp franchise tax: Applies even if you make $0 profit (FTB Guidance).
• California S Corp fee: 1.5% tax on net income, paid to CA FTB (in addition to federal taxes).
• Stricter compliance: Must stay on top of payroll filings, W-2 reporting, quarterly and year-end forms.

If you have or expect steady, growing profits ($100K+), and you’re ready for payroll, S Corp is almost always the smarter play. California’s franchise and income tax will bite — but not nearly as hard as self-employment tax on an LLC for incomes in six figures or more.

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

Common Mistakes: Why Most Owners Trip Up When Switching from LLC to S Corp

Here’s where well-meaning business owners lose their shirt:

• Missing the S Corp Election Window: File IRS Form 2553 within 75 days of the start of the tax year (see Form 2553 guidance). Miss it, and your S Corp runs as an LLC for a year — and you lose big on savings.
• Improper Salary Setup: Paying too little (or nothing) as a salary can trigger payroll audits, back taxes, and penalties.
• Commingled Funds: Mixing personal and business assets “pierces the veil” — inviting FTB and IRS scrutiny.
• Sloppy Bookkeeping: S Corps require exact records; missing wage filings or quarterly payments will guarantee fines.

Red Flag Alert: If you try to “DIY” your S Corp conversion in California, failing to notify the FTB or set up legal payroll exposes you to thousands in state penalties — far more than your annual tax savings.

Pro Tip: The S Corp decision is not “set it and forget it.” Review your income levels and compliance every year — especially if your business model or ownership changes.

What If I Only Have a Side Hustle? (W-2 + 1099 Scenario)

If you run a small side business alongside your day job (W-2), an LLC lets you keep it simple. Why? S Corp payroll and compliance rarely pay off unless your net profit exceeds $50,000–$60,000 annually from the side gig alone. If you cross that threshold (or grow fast), explore S Corp election for the next year.

But for real estate investors, the math flips: LLC is safer for liability. But if you’re active and generating significant service-based income, S Corp can unlock thousands in savings—if, and only if, you properly segregate rental and active business profits per IRS Publication 925.

See how we help self-employed and 1099 taxpayers select the right structure.

Step-by-Step: How to Choose (and Switch) Between LLC and S Corp in California

1. Start with Your Profit: Under $50K/year? Stick with LLC. Over $60K? S Corp is usually more tax-efficient.
2. Run the Numbers: Estimate your “reasonable salary” as an S Corp owner. Use last year’s net profit as a baseline.
3. File IRS Form 2553 for S Corp Election: Must file within 75 days; late elections need substantiation with the IRS.
4. Update Payroll, Bookkeeping, and State Filings: Set up W-2 salary through a payroll provider; update all CA filings to reflect the S Corp election.
5. Review Annually: Monitor legislative changes and your profit levels every year to ensure your entity choice stays optimal.

FAQs: What California Business Owners Ask Us First

Will switching to an S Corp save me money if profits drop?

No. If your business profit falls below $50,000, S Corp compliance and payroll fees can wipe out the benefit. Reevaluate every tax year.

Is it true S Corps avoid all CA state tax?

Absolutely not. S Corps face both the $800 franchise tax and a 1.5% state income tax on profits — on top of whatever you pay federally.

Can a real estate LLC become an S Corp?

You can elect S Corp status for an LLC, but you cannot do this for rental-only income safely. Active businesses: maybe. Passive investment properties: never S Corp unless you want tax and liability pain.

Will This Trigger an Audit?

Switching to an S Corp does not increase federal audit risk if properly set up. However, California’s FTB is aggressive on payroll compliance and franchise tax avoidance. Use a specialist — not generic tax software — to stay clear.

Book Your Tax Structure Strategy Session

Stop guessing whether an LLC or S Corp will save you more in California — let a strategy-driven pro audit your real numbers and entity filings for maximum cash savings. Click here to book your custom tax structure session now.