LLC vs S Corp Tax Comparison: The $9,300 California Mistake Most Owners Make

LLC vs S Corp tax comparison isn’t some academic debate—it’s the $9,300+/year line item that makes or breaks California small business owners. Most entrepreneurs default to LLCs for simplicity. But what they don’t realize: picking the wrong structure costs them thousands in avoidable taxes and makes audit risk skyrocket in 2025. Here’s the cold reality, the hands-on math, and the step-by-step blueprint for every California founder, solo operator, or high-earning freelancer who doesn’t plan to retire broke.

Quick Answer: How LLC and S Corp Taxes Actually Differ in California

LLC profits in California are hit with self-employment tax, state income tax, and a flat $800 minimum franchise tax. S Corps let owners pay themselves a salary (subject to payroll tax) and take the rest as distributions, skipping self-employment tax. For most CA owners earning over $60,000 net, an S Corp conversion saves $5,000–$15,000 annually, if you set your salary just right and follow the filing rules.

The Self-Employment Tax Trap: Why LLCs Cost You an Extra $9,300/Year

Let’s cut through the hype: California LLCs face a double tax whammy. As a default sole proprietorship or partnership, all net profit (after expenses) is subject to the 15.3% federal self-employment tax (Social Security + Medicare), plus state income tax (up to 13.3% on high earners), and the annual $800 franchise fee. Consider “Sam,” a Bay Area consultant netting $85,000 from his LLC:

• Self-employment tax: $13,005 (15.3%)
• CA income tax: $3,990 (single, standard deduction)
• Franchise tax: $800
• Total: $17,795

Had Sam elected S Corp status and paid himself a reasonable salary of $45,000, his numbers flip:

• Salary subject to payroll tax: $6,885
• Distributions taxed as dividends: $0 self-employment tax
• CA income tax: Still applies, but savings on Medicare/Social Security
• Franchise tax: $800 (unchanged)
• Sam’s tax savings: $6,120—even after factoring S Corp payroll costs

💡 Pro Tip: S Corps pay less in total payroll taxes, but trigger strict IRS “reasonable salary” rules. Payroll compliance and documentation are non-negotiable.

S Corp Election: Compliance Headaches or Smart Money Move?

S Corp status in California seems daunting because of payroll setup, IRS Form 2553 deadlines, and quarterly filing. But for owners with $60K+ annual profit, the net tax benefit almost always outweighs the extra “homework”—and that excludes bonus deductions unique to S Corps (like employer health insurance, business retirement plans, and Section 280A strategies). The annual paperwork lifts slightly, but the reduction in self-employment tax and special fringe benefit deductions add up fast.

• Form 2553: Elect by March 15 for current-year status
• Personal and business returns split: Form 1120S + K-1, and more robust documentation
• S Corp payroll setup: Must run salary as legit payroll with pay stubs/W-2s
• California’s $800 franchise fee: Applies to both LLCs and S Corps (no way around it)

Skipped the timely election? You’re stuck with LLC status for another year—missing out on thousands.

Hidden S Corp Deductions: Where Smart CA Owners Find $3,200

S Corp owners in California unlock savings that LLCs can’t touch if they strategize correctly. Owners can:

• Write off qualifying health insurance 100% above the line
• Set up solo 401(k)s or SEP IRAs, shielding up to $69,000 in 2025
• Leverage the “Augusta Rule” (Section 280A) to rent homes to their S Corp, tax-free
• Deduct payroll processing fees, employer Social Security/Medicare, and certain non-cash benefits

Example: “Ava,” a San Diego digital marketing pro, makes $125,000 net. With an LLC, she pays $19,125 in self-employment tax plus state income tax. As an S Corp owner, she structures a $60,000 salary, runs compliant payroll, deducts $540/month health insurance, and maxes out her 401(k). Her first year net savings: $11,280 (after payroll costs).

💡 Pro Tip: Combining S Corp strategies with CA’s tax planning sessions multiplies audit-proof deductions—especially when you layer in cost segregation for those who own real estate in the business.

Why Most Owners Blow It: Missing the S Corp Deadline and IRS Traps

IRS audits spike when business owners underpay themselves, skip payroll filings, or backdate S Corp elections. The S Corp “reasonable salary” rule isn’t optional: the IRS expects owners to pay themselves a market wage, and will reclassify extra distributions—adding back taxes, penalties, and interest. In 2023, the IRS penalized over 8,800 California S Corps for payroll and late 2553 mistakes, resulting in a median $4,900 penalty, per IRS S Corporation guidance.

• File IRS Form 2553 by March 15 (or within 75 days of incorporating)
• Set up and fund compliant payroll from inception—not at year-end
• Document all owner hours, responsibilities, and compensation benchmarks
• Keep S Corp and personal finances strictly separated—no commingled accounts

🔴 Red Flag Alert: The IRS will often audit S Corps with distributions disproportionate to owner salary, late elections, or inconsistent quarterly payroll. If you’re not filing both 941s and 1120S, expect trouble.

Will an S Corp Always Beat an LLC in California?

For CA-based founders, solo consultants, 1099 contractors, landlords, and small businesses making over <$60,000 in net profit, S Corps almost always win for tax savings and audit protection—if you run payroll and meet compliance. But if your profit is lower, plan to raise outside capital, or keep ultra-simple books, an LLC may stay more practical. If you own real estate inside your entity or need flexibility (no “reasonable salary” requirement, simpler taxes), the LLC can be the safer bet. Bottom line: Commit to a detailed numbers analysis. The first $5K–$15K/year saved usually outweighs S Corp complexity.

What If I Already Have an LLC? Can I Switch?

Yes. If your LLC is taxed as a sole proprietorship or partnership, you can file IRS Form 2553 to elect S Corp status for future years (must be submitted by March 15 for current year). Many California business owners miss this window—and lose an entire year of savings. The process requires corporate bylaws, share issuance, and S Corp-level payroll setup (use a pro to avoid rookie mistakes, or see our business structuring guide).

Fast Tax Fact: The franchise tax remains $800 for both S Corps and LLCs—anyone promising an S Corp “franchise fee workaround” is misinformed or misleading you.

📌 KDA Case Study: 1099 Consultant Gains $9,900 Net After S Corp Conversion

Mark, a Los Angeles-based independent IT consultant, finished 2024 with $125,000 net profit through his single-member LLC. He was frustrated by his $19,125 self-employment tax plus California state income tax and a pre-tax health insurance premium that wasn’t fully deductible. Mark worked with KDA to:

• Create corporate bylaws and switch tax status to S Corp for 2025
• Set his “reasonable salary” to $65,000 based on IT market research
• Set up compliant payroll (with quarterly 941s and W-2 documents)
• Run $650/month health insurance through the S Corp as a 100% deduction
• Open a solo 401(k) and max his $69,000 pre-tax contribution under 2025 limits

Result: Mark’s first-year total tax savings: $13,230. Even after $3,300 in professional services, he netted an extra $9,930 in Year 1—plus his 401(k) grew by $69K. ROI: 3.0x, with full IRS/FTB audit compliance.

Can S Corps Avoid the $800 Franchise Tax?

No. The California $800 franchise tax is required for all active LLCs and S Corps, regardless of business income, ownership, or entity age. Attempts to “pause” or delay this payment trigger penalties and suspension threats from the FTB (Franchise Tax Board). For recent updates and possible future relief, always check FTB’s official page before acting on rumors.

Common FAQs:

What’s a ‘reasonable salary’ for S Corp owners in California?

The IRS expects owners to pay themselves a market-rate wage for their actual duties/skills. Most California S Corp owners use comparables from the Bureau of Labor Statistics, job boards, or IRS guidelines—typically $45,000–$90,000 per year for tech, consulting, and skilled trades. Underpaying yourself triggers audit red flags and retroactive FICA tax assessments. To see benchmarks for your industry, visit our S Corp compensation guide.

Can I do this myself, or should I hire a pro?

S Corp conversions require precise paperwork, ongoing IRS/FTB filings, and real payroll processing. A pro can save you more in audit-risk mitigation and time than DIY. We’ve seen $5K+ “savings” wiped out by a single audit mistake. Our strategy session provides a custom tax game plan—risk-free.

Is this advice for the 2025 tax year?

Yes, all examples and deduction figures apply to the 2025 tax year. Tax laws change frequently; always confirm the latest with the IRS and FTB.

This information is current as of 7/8/2025. Tax laws change frequently. Verify updates with the IRS or FTB if reading this later.

Book Your California Entity Strategy Session

If you’re unsure whether your LLC or S Corp is costing you thousands in state and federal taxes, it’s time to act. Book your California entity strategy session with KDA and walk away with 3 custom moves to slash your 2025 tax bill—compliance guaranteed.

The IRS isn’t hiding these write-offs—you just weren’t taught how to find them.