Most California business owners pick their entity structure once and never look back. That’s the mistake. The difference between running your business as a partnership, an S Corp, or a C Corp isn’t just paperwork — it’s often $15,000 to $27,000 in annual tax liability, paid to the IRS and the California Franchise Tax Board every single year. And because California layers its own franchise tax, SDI requirements, and FTB compliance rules on top of federal law, the wrong entity choice stings twice.

This guide breaks down the real tax advantages of each structure in plain English — with specific dollar amounts, California-specific rules, and the precise scenarios where each entity wins. Whether you’re earning $80,000 or $500,000 from your business, understanding the S Corp vs C Corp vs partnership tax advantages is the single most important financial decision you’ll make before year-end.

Quick Answer: Which Entity Pays Less Tax?

For most California small business owners earning between $60,000 and $400,000 in net profit, an S Corporation delivers the largest tax reduction because it eliminates self-employment tax on distributions while passing income through to the owner’s personal return. Partnerships offer simplicity and flexibility but expose owners to full self-employment tax. C Corporations can benefit high earners planning for institutional investment or a future exit, but create double taxation that eliminates most of their appeal for small operators. The exact winner depends on your income level, exit strategy, and whether you can justify a reasonable salary.

How Each Entity Is Actually Taxed (Not the Textbook Version)

Before comparing tax advantages, you need to understand what the IRS actually does with your income under each structure. Most explanations oversimplify this. Here’s the real picture for 2026.

Partnerships: Pass-Through With a Hidden Tax Trap

A partnership — including a multi-member LLC taxed as a partnership — passes all income directly to the partners’ personal tax returns. That sounds great, until you realize that partners who are active in the business pay self-employment (SE) tax on their entire share of ordinary business income.

For 2026, the SE tax rate is 15.3% on the first $176,100 of net earnings and 2.9% above that threshold. If you and a business partner each receive $120,000 from your partnership, you each owe roughly $16,956 in SE tax on top of your regular federal income tax bracket. That’s before California’s state income tax takes its share — which can reach 13.3% at the top bracket.

Partnerships file IRS Form 1065 and issue Schedule K-1 to each partner. Partners then report their share of income, deductions, and credits on their personal Form 1040. California requires a separate Form 568 for LLCs taxed as partnerships, plus the $800 annual franchise tax minimum and a gross receipts fee that scales up to $11,790 for businesses earning over $5 million.

S Corporations: The Self-Employment Tax Firewall

An S Corporation is also a pass-through entity — meaning income flows through to shareholders’ personal returns and avoids corporate-level tax. But here’s where the strategy kicks in: S Corp shareholders who work in the business must pay themselves a reasonable salary, which is subject to payroll taxes (Social Security and Medicare). The remaining profit distributed as a shareholder distribution is NOT subject to SE tax.

That distinction creates real savings. If your S Corp generates $180,000 in net profit and you pay yourself a $90,000 salary, only the salary portion ($90,000) triggers payroll taxes. The remaining $90,000 distributed as a shareholder draw avoids the 15.3% SE tax hit — saving you approximately $8,775 in federal taxes alone.

S Corps file IRS Form 1120-S and issue Schedule K-1 to shareholders. In California, S Corps pay an additional 1.5% franchise tax on net income, with an $800 minimum. The FTB requires Form 100S annually. There’s also a critical deadline: to elect S Corp status for a given year, you must file IRS Form 2553 no later than 2 months and 15 days after the start of the tax year — or March 17, 2026, for most calendar-year businesses electing for 2026.

For a deeper breakdown of California-specific S Corp strategy, our complete guide to S Corp tax strategy in California covers reasonable salary rules, FTB compliance, and the election process in detail.

If you want to estimate how much your current business structure is costing you, plug your numbers into this small business tax calculator to see the real difference between entity types on your actual income.

C Corporations: Double Taxation Is Real — Here’s When It Doesn’t Matter

A C Corporation is taxed at the entity level — currently a flat 21% federal rate — and then shareholders pay tax again when profits are distributed as dividends (qualified dividends are taxed at 0%, 15%, or 20% depending on your bracket). California adds its 8.84% franchise tax on top, with an $800 annual minimum.

This “double taxation” makes C Corps look unattractive for most small businesses. But there are legitimate scenarios where C Corps win:

• Venture-backed startups seeking institutional investors (S Corps can’t have more than 100 shareholders or corporate shareholders)
• Businesses planning an IPO or acquisition by a private equity firm
• High-income owners who retain most profits in the business and don’t need distributions
• Businesses with significant fringe benefit needs — C Corps can fully deduct employee benefits including medical reimbursement plans
• Companies accumulating cash for future expansion where 21% is less than the owner’s personal rate

If none of those scenarios describe you, the C Corp structure almost certainly costs more than it saves. Our entity formation services help California business owners make this decision based on real numbers, not assumptions.

The Real Dollar Comparison: Three Business Owners, Three Outcomes

Here’s where the abstract becomes concrete. Let’s walk through three identical business owners — all generating $200,000 in net business profit — under each entity structure in California for 2026.

Owner A: Partnership (Multi-Member LLC)

• Net business income: $200,000
• SE tax on full amount: ~$22,511 (15.3% up to $176,100, 2.9% above)
• Federal income tax (assume 22% bracket after deductions): ~$30,000
• California state tax (assume 9.3%): ~$18,600
• California franchise tax minimum: $800
• Estimated total tax liability: ~$71,911

Owner B: S Corporation

• Net business income: $200,000
• Reasonable salary set at: $90,000
• Payroll taxes on salary: ~$13,770 (split employer/employee)
• Distribution (not subject to SE tax): $110,000
• Federal income tax (same bracket): ~$30,000
• California state tax: ~$18,600
• California 1.5% franchise tax: $3,000
• Estimated total tax liability: ~$65,370
• Annual savings vs. partnership: approximately $6,541

Owner C: C Corporation (Taking Salary Only)

• Corporate profit: $200,000
• Federal corporate tax (21%): $42,000
• California franchise tax (8.84%): $17,680
• After-tax profit retained in business: $140,320
• If distributed as dividends: taxed again at personal rates (15–20%)
• Effective combined tax rate on distributions: often 45–55%

For the owner who wants cash in hand today, the C Corp structure is the most expensive option by a wide margin at the $200,000 income level. The S Corp wins on pure tax savings, and the partnership is a close second for owners who aren’t yet ready to run payroll.

Many business owners discover this comparison during their first year and realize they’ve overpaid the IRS by tens of thousands simply because their initial entity choice wasn’t reviewed by a strategist.

KDA Case Study: Sacramento Consultant Switches from Partnership to S Corp

Marcus ran a two-person management consulting practice in Sacramento organized as a multi-member LLC taxed as a partnership. He and his business partner each received $145,000 in pass-through income annually. Neither had ever questioned their structure — their original attorney set it up, and their CPA filed the returns every year without comment.

When Marcus came to KDA, our team ran a full entity analysis. The numbers were clear: both partners were paying self-employment tax on their full $145,000 share each year — roughly $19,800 per person in SE tax alone, totaling $39,600 annually between them. By converting to an S Corporation and setting reasonable salaries of $75,000 each, the remaining $70,000 per partner ($140,000 total) would flow as distributions exempt from SE tax.

KDA managed the IRS Form 2553 election, set up a payroll system through a California-registered payroll provider, and filed the FTB transition documents. In year one, Marcus and his partner saved a combined $17,010 in self-employment tax — after accounting for the California 1.5% franchise tax on S Corp net income and the cost of running payroll. KDA’s annual advisory fee was $4,800. Their first-year return: 3.5x on their investment.

Marcus’s comment six months in: “We’ve been paying $17,000 a year for a structure our accountant never once suggested changing. That ends now.”

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.

S Corp Tax Advantages You’re Probably Underutilizing

Most business owners know that S Corps save self-employment tax. Fewer know about the additional tax advantages layered on top of the core benefit.

Accountable Plan Reimbursements

S Corp shareholders can be reimbursed for business expenses through a formal accountable plan under IRS Publication 15. This includes home office expenses, vehicle mileage, cell phone costs, and professional development. These reimbursements are deductible at the corporate level and tax-free to the shareholder — unlike a partnership where these deductions are limited and often subject to the 2% AGI floor that was eliminated for individuals but still creates complexity.

Section 199A Qualified Business Income Deduction

S Corp shareholders may qualify for the 20% Qualified Business Income (QBI) deduction under IRC Section 199A — a provision made permanent under the Tax Cuts and Jobs Act for 2026. On $110,000 in S Corp distributions, a 20% deduction reduces taxable income by $22,000. At a 22% federal bracket, that’s a $4,840 reduction in federal tax that most partnership structures can also claim, but S Corps provide better structural clarity for it.

Health Insurance Premium Deduction for Shareholders

S Corp shareholders who own more than 2% of company stock can deduct 100% of health insurance premiums paid on their behalf. The premium must be included in the shareholder’s W-2 wages, but it’s then deductible as a self-employed health insurance deduction on the personal return. Partnerships handle this similarly, but the S Corp structure makes the tracking and reporting cleaner.

Solo 401(k) Contributions Based on W-2 Wages

An S Corp shareholder can make both employee and employer contributions to a Solo 401(k) based on their W-2 salary. If your reasonable salary is $90,000, you can contribute up to $23,500 as an employee deferral (2026 limit) plus 25% of compensation as an employer contribution — totaling up to $69,000 for the year. This dramatically reduces taxable income in ways that partnership structures often can’t match without careful planning.

Why Most Business Owners Miss the S Corp Timing Window

One of the most expensive mistakes California business owners make is missing the S Corp election deadline. The IRS requires that Form 2553 be filed no later than 2 months and 15 days after the start of the tax year for the election to take effect that same year. For calendar-year businesses, that means March 17, 2026, for tax year 2026.

Miss that window, and your S Corp election takes effect in 2027 — meaning you pay the partnership or C Corp tax rate for the entire current year even if you incorporated in January.

California adds its own wrinkle: you must also file FTB Form 3560 (the California S Corporation Election) within 12 months of the federal election. Failing to do this means California still treats your entity as a C Corp for state purposes — even if the IRS recognizes your S Corp status. That means California will assess the 8.84% corporate franchise tax instead of the 1.5% S Corp franchise tax on your California-sourced income.

Red Flag Alert: If you elected S Corp status with the IRS but never filed the California FTB Form 3560, you may have been paying the wrong franchise tax rate for years without knowing it. This is a surprisingly common error that a professional entity review can catch and correct.

When to Choose Each Entity: A Clear Decision Framework

Choose a Partnership (Multi-Member LLC) When:

• Your business is in the early stages with profits under $50,000
• You need maximum structural flexibility for profit-sharing arrangements
• Your partners have unequal ownership percentages that shift over time
• You don’t want the complexity of running payroll
• Your entity has losses in early years (partnerships can allocate losses flexibly)

Choose an S Corporation When:

• Your net business profit consistently exceeds $60,000 annually
• You can justify and document a reasonable salary for your work
• You’re a U.S. citizen or resident and have fewer than 100 shareholders
• You want to retain QBI deduction eligibility with clearer structuring
• You’re building a business you plan to run (not sell to institutional buyers)

Choose a C Corporation When:

• You’re raising venture capital and need to issue preferred stock
• You’re building toward an IPO or institutional acquisition
• You need to retain large amounts of capital inside the business at the 21% corporate rate
• You plan to offer employee stock options (ISOs) to attract and retain talent
• Your personal income tax rate exceeds 35% and you plan to leave profits in the company

California-Specific Compliance Traps That Change the Math

Whatever entity you choose, California will apply its own rules on top of federal law. These aren’t optional considerations — ignoring them creates FTB penalties that quickly erode any tax savings from your structure.

The $800 Minimum Franchise Tax (Every Entity Pays It)

Every LLC, S Corp, and C Corp registered in California owes at least $800 per year to the FTB — regardless of whether the business made a single dollar. This is the California franchise tax minimum, and it applies even to businesses in their first year of operation. New LLCs formed after January 1, 2021, are exempt for their first taxable year, but this relief does not apply to S Corps or C Corps.

California’s Non-Conformity to Federal Bonus Depreciation

California does not conform to federal bonus depreciation rules under IRC Section 168(k). While the federal government may allow 100% first-year bonus depreciation on qualifying assets, California limits the deduction and requires addback adjustments on California returns. This means a C Corp or S Corp that claims $50,000 in federal bonus depreciation may see very different California taxable income — and potentially owes more state tax than expected.

California Gross Receipts Fee for LLCs

California LLCs (including those taxed as partnerships or S Corps) owe an annual gross receipts fee based on total revenue — not profit. At $250,000 to $499,999 in gross receipts, the fee is $900. At $1 million to $4,999,999, it jumps to $6,000. This fee stacks on top of the $800 minimum and applies even if the business has zero net income. Plan for this when projecting your annual tax cost by entity type.

Common Mistakes That Trigger an IRS or FTB Challenge

The biggest risk in S Corp planning isn’t the structure — it’s poor execution. The IRS actively scrutinizes S Corp returns for unreasonably low shareholder salaries. If your S Corp generated $300,000 in profit and you paid yourself a $30,000 salary, that’s a red flag that will likely trigger a payroll tax audit.

Similarly, the FTB compares S Corp franchise tax filings against payroll records. Discrepancies between reported wages and distributions can prompt an inquiry that results in back taxes, penalties, and interest.

Other common errors include:

• Failing to maintain a separate business bank account and corporate minutes
• Making distributions from an S Corp with zero payroll — no salary, no distributions
• Mixing personal expenses with business expenses and claiming them as deductions
• Missing the California Form 3560 S Corp election after the federal Form 2553 was filed
• Not running payroll quarterly, which can trigger underpayment penalties from both the IRS and EDD

This information is current as of 2/28/2026. Tax laws change frequently. Verify updates with the IRS or FTB if reading this later.

Frequently Asked Questions

Can a single-member LLC elect S Corp status?

Yes. A single-member LLC is taxed as a sole proprietorship by default but can elect S Corp status by filing IRS Form 2553. Once elected, the owner is treated as an employee-shareholder and must run payroll. This is one of the most common and effective tax-saving strategies for solo business owners earning $60,000 or more in net profit.

How do I know if my S Corp salary is “reasonable”?

The IRS defines a reasonable salary as what you would pay an arm’s-length employee to perform the same work. The standard factors include your industry, experience level, time devoted to the business, and comparable wages in your region. A salary of 40%–60% of net profit is a common benchmark, but this must be supported with documentation — not just chosen arbitrarily.

Do partnerships file a tax return?

Yes. Partnerships file IRS Form 1065 annually and issue a Schedule K-1 to each partner showing their share of income, deductions, and credits. Partners report this information on their personal Form 1040. In California, multi-member LLCs file FTB Form 568 and pay the $800 minimum franchise tax plus any applicable gross receipts fee.

What happens if I want to convert from an S Corp back to a C Corp?

Converting from S Corp to C Corp status is a one-way door for five years. Under IRS rules, once a corporation revokes its S Corp election, it cannot re-elect S Corp status for five years without IRS consent. Plan your structure with a long-term view — conversions have consequences that compound over time.

Can a C Corp owner take a salary to reduce corporate taxable income?

Yes. A C Corp owner-employee can take a salary that is deductible at the corporate level, reducing the company’s taxable income. This is one of the ways C Corp owners reduce the double-taxation problem. However, the IRS scrutinizes excessive executive salaries in closely held C Corps, so the salary must still be reasonable relative to the owner’s role and industry benchmarks.

Key Takeaway: The S Corp vs C Corp vs partnership comparison is not an abstract academic exercise — it is a real, calculable dollar amount that changes every year based on your income, your state, and the structure you’re operating under. Most California business owners are overpaying by $6,000 to $27,000 annually simply because no one has ever run the numbers.

“The IRS doesn’t care which entity you chose — it cares which one you’re taxed under. Pick the wrong one and they’ll be happy to collect the difference.”

Stop Overpaying: Book Your Entity Tax Strategy Session

If you’re running your business as a partnership or a C Corp without a clear, documented reason for that structure, there’s a high probability you’re leaving money on the table every single year. Our team at KDA has run entity comparisons for hundreds of California business owners — and the most common outcome is discovering $8,000 to $27,000 in recoverable annual tax savings through an S Corp election or entity restructure.

We’ll review your current entity structure, run the numbers for your exact income level, and give you a clear recommendation with projected savings before you commit to anything. Click here to book your entity tax strategy consultation now.