Switching from an S Corp to a C Corp: The Tax Shake-Up That Can Change Everything for California Businesses in 2025
More California business owners are surprised by tax bills in 2025 after switching from an S Corp to a C Corp than ever before. Whether you’re chasing easier fundraising, prepping for a high-growth exit, or just following your CPA’s advice, this decision reroutes your entire federal and state tax journey—in ways that can cost six figures or unlock new wealth. Let’s cut through confusion and show you exactly what’s at stake.
Quick Answer: What Changes When You Go from S Corp to C Corp?
When a business switches from S Corp to C Corp status, income is taxed at both the corporate and shareholder level (double taxation). You gain flexibility for investor ownership but lose key S Corp flow-through benefits and potentially face built-in gains tax, state franchise fees, and new compliance hoops. For high-earning California businesses—especially those with outside investors—this move can mean both higher taxes and bigger opportunities.
The S Corp-to-C Corp Switch: Why Business Owners Take the Leap
Most S Corp owners think they’ve solved their tax headaches, but doors start closing when you want bigger, more complex growth. S Corps can’t have more than 100 shareholders, can’t issue multiple stock classes, and they hit snags if a single non-U.S. person wants in.
- Fundraising Roadblocks: Venture capital and institutional investors almost never invest in S Corps. Going C Corp is a must if you’re chasing big money.
- Exit Strategy Triggers: Many buyers will pay a premium to acquire a C Corp. Others may force a conversion as part of a transaction.
- Ownership Flexibility: C Corps can issue stock options to employees, bring in foreign shareholders, and offer all-star retention plans—none possible under S Corp rules.
But here’s what’s rarely discussed: you also hand the IRS more opportunities to tax your profits and create compliance traps (full breakdown in our S Corp tax guide).
KDA Case Study: SaaS Founder Flips to C Corp for Series A — and Discovers a $62,000 Surprise
Meet Chris, a SaaS entrepreneur in San Jose, single founder, $1.2 million gross revenue with 52% net margin. He was an S Corp for five years, paying himself a mix of salary and distributions. Then in 2025, a VC firm makes a $2M Series A offer—with one catch: convert to C Corp now.
KDA mapped the transition on a tight timeline. Chris got his funding. But in the first year, he faced:
- Double taxation: $310,000 corporate tax at 21% federal rate (+8.84% California)
- Distribution dividend hit: $115,000 qualified dividend taxed on his return
- “Built-in gains” specter: $62,000 IRS built-in gains exposure from selling earlier S Corp assets
KDA slashed his potential built-in gains tax using Section 1374 planning, adjusted payroll, and staged the distribution to mitigate dividend damage. Still, the client paid $3,800 for a detailed entity strategy and transition package but saw $68,400 overall tax savings and secured capital for a $7M valuation uplift.
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 Owners Miss the Hidden Taxes When Switching from an S Corp to a C Corp
The most overlooked cost in this switch is “built-in gains” tax. If you convert and then sell appreciated assets (like IP or real estate) within five years, the IRS treats those gains as if you sold them while still an S Corp—stacking a C Corp tax on top. In 2025, California adds another layer of franchise and income taxes.
- Example: Linda owns an LA consulting firm, S Corp since 2017. She converts to C Corp in January 2025, sells $400,000 in old S Corp software code a year later. Her total effective tax: 21% federal + 8.84% CA + up to 37% on built-in gains bracket. Her “savings” from going C Corp? Negative $41,000 if not planned right.
What about state registration fees?
C Corps in California pay an annual $800 franchise tax plus a percent on net income. S Corps pay these too, but the C Corp franchise tax can scale quickly with profit—do the math before switching.
Step-By-Step: How to Convert Your S Corp to a C Corp (the IRS Way)
The IRS doesn’t have a direct “S Corp to C Corp conversion” form. When you decide to switch, you simply revoke your S election by sending a signed statement to the same IRS service center where you file your S Corp return. Here’s how it works for tax year 2025:
- Board/Owner Approval: The S Corp board or all shareholders must approve the change.
- IR S Election Revocation: File a signed statement per IRS instructions. Effective date can matter—choose carefully.
- State Filing: Update your status with the California Secretary of State.
- Payroll and Withholding Update: Reclassify owner/officer pay as W-2 wages, and update employee stock comp as needed.
- Franchise Tax Board Compliance: File the first 1120 (C Corp) and last 1120S (S Corp) properly—this is a major audit trigger if you botch it.
For more about entity setup, see our entity formation services.
Potential Tax Savings—and Pitfalls—of a 2025 S to C Conversion
Converting to a C Corp can lower your short-term taxable income if you plan to hold profits inside the company (for reinvestment, not distributions).
- Corporate federal tax rate remains 21%. California C Corp tax is 8.84%, S Corp is 1.5%—that differential erases S Corp’s advantage if you’re not distributing profits back out.
- Retained earnings: Unlike S Corps, C Corps can retain income without triggering an immediate pass-through to owners. This is a win for scaling startups and high-growth companies.
- QSBS Exclusion: If you convert and issue new stock, gains from selling stock after five years may qualify for the Qualified Small Business Stock (QSBS) exclusion—potentially up to $10M is tax-free at federal level (see IRS Notice 2018-39).
Can I switch back to an S Corp later?
Yes, but with restrictions. Once you switch to a C Corp, you usually must wait five tax years before re-electing S Corp status—and you can’t have ineligible shareholders or multiple stock classes. Plan for a multi-year road if you want flexibility later.
Common Mistake That Triggers an Audit
The #1 trap: Failing to properly close out S Corp books before converting. If you commingle S Corp and C Corp period income, payroll, or expenses, the IRS and California FTB can both disallow deductions and impose penalties. Document shareholder loans, distributions, and retained earnings as of the day before C Corp status kicks in. Don’t transfer assets or IP without revaluation—you could inadvertently create a taxable event or show “phantom income” to the IRS.
Red Flag Alert:
California FTB is notorious for auditing first-year conversions. In 2025, these cases jumped by 18%. Use an advisor who walks through each payroll, dividend, loan, and property transfer. For audit defense, see our audit representation services.
Pro Tip: Section 1202/Qualified Small Business Stock Strategy
Planning to sell your company eventually? If you set up your new post-conversion C Corp shares to qualify as QSBS, you may exclude the first $10M of capital gain at federal level—massive for startup founders and VCs.
For more advanced C Corp tax moves and planning, see our S Corp tax guide.
FAQ
Will switching from S Corp to C Corp save me money in 2025?
If you expect to reinvest profits and avoid dividends, possibly yes. But if you plan to distribute most profits—or have appreciated assets and IP—the double tax hit can overwhelm any single-year advantage. Run detailed scenarios before filing the revocation.
What forms do I need to file in California?
You’ll need to file Form 1120S for your final S Corp period, Form 1120 for the C Corp, and update your status with the California Secretary of State and FTB (Form 100). Your state accountant is critical here—mistakes can cause penalties or loss of good standing.
Can a single-member LLC do this?
Yes. If you’re taxed as an S Corp, you can revoke and be taxed as a C Corp. But be aware of franchise tax and QSBS eligibility rules.
What If I Want to Add Foreign or Institutional Investors?
This is when conversion can be a smart move. C Corps allow for this, S Corps do not. Just be ready for new reporting requirements, stricter corporate governance, and the complexity of double taxation on future distributions to U.S. shareholders.
This information is current as of 10/27/2025. Tax laws change frequently. Verify updates with the IRS or FTB if reading this later.
Book Your 2025 C Corp Tax Impact Review
If you’re considering (or being forced into) a C Corp switch, don’t roll the dice with the IRS and FTB. Book a personalized C Corp entity analysis with our team and avoid the audit, franchise tax, and built-in gains traps that cost businesses tens of thousands. Click here to book your consultation now.
