LLC vs S Corp in California: The Hidden Tax Difference Every Owner Needs to Know
Most California business owners hesitate to switch their business structure because they’re bombarded by half-true “facts” about LLCs and S Corps. Yet, what no one is telling you: picking the wrong entity could leave you overpaying the state $8,000-27,500 or even worse—risking an audit you don’t see coming. If you’re running a business or earning substantial 1099 income in California, understanding the difference between LLC and S Corp California isn’t just a technical detail—it can put thousands in your pocket year after year.
Fast Tax Fact: The Core Difference that Impacts Your Wallet
Here’s the bottom line: In California, LLCs pay a flat $800 minimum franchise tax plus a graduated gross receipts fee, while S Corps pay the $800 fee but only a 1.5% tax on net income. Add in the way self-employment taxes, profit distributions, and audit risk differ, and choosing your entity can swing your take-home by five-figures annually.
Cracking the LLC in California: Simplicity Comes at a Price
LLCs in California offer simple setup and broad legal protection. But simplicity hides a tax trap: the state’s “gross receipts fee.” For most LLCs, the $800 minimum tax is just the start; once revenue exceeds $250,000, you’re hit with fees ranging from $900 to $11,790—regardless of your actual profit. Example: If your consulting firm brings in $800,000 in client billings during 2025, you pay the $800 minimum plus an additional $6,000 (gross receipts fee), regardless if your actual net profit was half or less.
- Who Benefits: Side hustlers, landlords with single properties, and businesses with low gross revenue
- Who Gets Burned: Service agencies, consultants, tech contractors, and anyone with high top-line sales
IRS-Defined Trap: The IRS treats LLC income as “self-employment income.” That means you pay both the employer and employee side of Social Security and Medicare—up to 15.3%—on every dollar of profit. California does not reduce your self-employment tax when you own an LLC.
What If You Have Multiple Members?
Multi-member LLCs don’t escape higher taxes either. The state splits fees among members, but total liability remains the same. If your business is growing, you could break $100K+ in unnecessary annual fees over five years.
An S Corp in California: Lower Taxes, More Rules
S Corps flip the tax table. Though you still pay the $800 minimum state tax, your net income (after business expenses and reasonable owner salary) gets taxed at only 1.5%. But here’s the seismic shift: Distributions from S Corps aren’t subject to self-employment tax. Only your payroll salary is. This means you control how much of your income is taxed at the high 15.3% self-employment rate versus the much lower S Corp rate.
- Who Benefits: Solo consultants, professional practices, established agencies, even many real estate flippers over $100K profit
- Who Gets Burned: Hobbyists, casual landlords, and ultra-high earners who don’t want the admin burden
Real-World Example: Sandy owns a digital marketing firm pulling $350,000 in revenue and $225,000 in net profit for 2025. As an LLC, she pays $800 minimum tax, a $3,000 gross receipts fee, and about $34,000 in self-employment tax. Convert that to an S Corp, pay herself a $100,000 salary (subject to regular payroll tax), and take the rest as distributions. Instantly, she drops her employment tax bill by roughly $11,000 per year—and cuts the state tax rate by two-thirds on her remaining profits.
What’s a “Reasonable Salary” for S Corps?
The IRS and California FTB expect S Corp owners to take “reasonable compensation”—what you’d pay someone else to do your job. Underpay yourself, and you risk audit (with huge back-tax penalties); overpay, and you lose the tax advantage. For guidance, see our in-depth S Corp tax planning guide.
🔴 Red Flag Alert: Common Trap That Triggers IRS and FTB Audits
Owners picking “LLC for simplicity” or “S Corp to look professional” often fail to optimize payroll or keep ironclad records, which are audit triggers for the IRS and California FTB. Underpaying your S Corp salary can easily get you flagged. Likewise, reporting high LLC profits with little or no tax withholding alerts the FTB to dig into your records (especially for $200,000+ profit businesses).
- Absent payroll for S Corp—audits and big fines
- LLC gross receipts over $250K—expect compliance letters, even if your profit is low
- Misclassification of contractor vs. employee status (especially under AB5 rules)
Fastest Fix: If you became profitable this year, don’t wait until tax time. Talk to a pro now to split income and salary for S Corps, or assess if your LLC is quietly bleeding cash to the state.
Review your entity structure with a seasoned expert here.
💡 Pro Tip: If your business is on the edge—revenue over $250,000, profits over $75,000—run a side-by-side S Corp vs. LLC tax simulation. Don’t just trust online calculators; each $50,000 in profits could swing your total taxes by $7,000-15,000.
📌 KDA Case Study: Taking Home $15K More by Going S Corp
“Marcus,” a Bay Area physical therapist with rising 1099 income, was operating as a single-member LLC. In 2024, he crossed $375,000 in revenue. Between California LLC gross receipts fees and full self-employment tax, his annual tax hit broke $58,000. The KDA team ran detailed simulations and switched Marcus to an S Corp in Q1 2025. We set a market-reasonable salary for his clinical hours ($110,000), automated payroll tax filings, and structured the remaining profit as distributions. Marcus’s actual tax savings: $15,340 in the first year, after accounting for additional payroll service costs and CPA fees ($3,900). ROI: 3.9x in year one, with lower audit risk and full compliance. Marcus can now reinvest his extra take-home into hiring and expanding his practice.
How to Decide: Is an LLC or S Corp Better for Me in California?
- Choose LLC if: You’re running low-gross or part-time gigs, want zero paperwork, or hold rental property with limited comps.
- Choose S Corp if: You’re at $75,000+ net profit, want to split salary and profit, are ready for more structured bookkeeping, and want to reduce self-employment tax.
Pro-tip: The math swings further toward S Corp once annual profits exceed about $70,000. But only if you pay yourself a legitimate salary, file all quarterly and payroll forms, and maintain books that stand up in an audit.
- LLC: low paperwork, higher taxes at scale, major state fees
- S Corp: higher compliance, lower long-term taxes, audit-friendly (if well managed)
Will Switching to an S Corp Trigger a Tax Audit?
Switching by the official deadline (2.5 months into the tax year; Form 2553 for IRS and CA), keeping all payroll and entity registrations up-to-date, and taking a reasonable salary eliminates most audit risk. Missing filings or large, abrupt changes in salary? That’s when the IRS/FTB notice you.
See: Book your tax entity review before you file.
How S Corps and LLCs Handle Retirement, Health, and Deductions
- S Corp: Can set up Solo 401(k), SEP-IRA, and even write off health insurance premiums (if on payroll).
- LLC: Still enables SEP-IRA, Solo 401(k), but you must pay self-employment tax before deductions matter. Can’t deduct health insurance directly as a business expense unless taxed as S Corp.
How Does This Impact My California State Tax Return?
S Corps require filing Form 100 (annual Franchise or Income Tax Return for S Corporations). LLCs file Form 568. Both structures pay the Franchise Tax Board, but S Corps’ unique allocation method may require dual filings if you convert during the tax year. For details, see California Form 100 and Form 568 instructions.
FAQ: What Business Owners Get Wrong (and Ask Next)
What’s the Deadline to Switch to S Corp Status in California?
You must file IRS Form 2553 (and CA 100-S if you’re already operating) within 2.5 months after the start of the tax year you want S Corp status. Miss it, and you’re stuck as an LLC for the year unless you qualify for “reasonable cause” relief.
Will S Corp Conversion Affect My PPP/EIDL/Other Relief Loan Qualifications?
Usually not, as long as you were a legitimate underlying business in operation prior to the program’s deadlines, but consult a pro for impact on specific state grant/relief programs.
What If My Business Consists of Real Estate or Passive Income?
The “active income” test matters: S Corps are for active businesses; rental income typically stays in LLCs (unless you materially participate). Review IRS/FTB guidance to avoid entity misclassification.
💡 Bottom Line for California Entrepreneurs
Making the right entity choice in California isn’t about titles—it’s about cutting unnecessary tax and defending against audit risk for 2025 and beyond. If you’re already at $75,000+ profit, the right structure can save upwards of $10,000 every year—and could even protect your assets in a lawsuit.
This information is current as of 7/21/2025. Tax laws change frequently. Verify updates with the IRS or FTB if reading this later.
Book a High-Retain Tax Strategy Session
If you’re ready to run the numbers and see how much a switch to S Corp—or a well-optimized LLC—could save you for 2025, book a personalized session with a KDA entity expert. Your first 30-minute call could deliver $8,000 to $20,000 in annual savings versus your current setup, and we’ll show you the exact steps to minimize FTB, IRS, and audit risk. Book now to make your entity work for you—not the taxman.
Social Media Mic Drop: “If you’re paying CA’s LLC fees with $100K+ profit, you’re burning cash. S Corps aren’t just for big companies—they’re the legal shortcut the state won’t tell you about.”
3 Quick-Use Snippets for Social, Email, Video
- LLC or S Corp? In CA, making the right call can save up to $27K a year—run your numbers now, not at tax time.
- Don’t get hammered by CA’s “silent” gross receipts fee—see if an S Corp can legally slash your state tax before you scale.
- 90% of new CA business owners get entity setup wrong. Audit-proof your structure in one strategy session with KDA.
For more direct, pro-level tax strategies: Visit our complete service menu or get smart with our Business Owner Tax Blueprint.
