What’s S Corp and C Corp? The Hidden $18,000 Divide Every California Owner Must Understand in 2025

Most California business owners don’t realize their legal entity choice could mean paying $18,000 more in taxes every year. Many assume “incorporating is good enough”—until they get blindsided at tax time by double taxation, payroll blunders, or missed California credits. If you’ve ever wondered what separates an S Corp from a C Corp—and which actually keeps more money in your pocket for the 2025 tax year—you’re in the right place.

Quick Answer: An S Corp is a corporation or LLC taxed as a pass-through entity: income flows directly to owners, who pay personal tax on profits, often at lower total rates if salary is structured right. A C Corp is a standard corporation, taxed at the corporate level (currently 21%), then shareholders pay tax again on dividends—creating classic “double taxation.”

Understanding whats s corp and c corp begins with how the IRS classifies the flow of income and employment taxes. An S Corp avoids the 15.3% self-employment tax on profit distributions, but the owner must take a “reasonable salary” under IRS §1366. A C Corp, by contrast, is taxed under IRC §11, meaning profits face a flat 21% corporate tax before dividends trigger a second personal tax layer. When cash extraction is your goal, these mechanics usually tilt the math heavily toward S Corp treatment.

This distinction impacts W-2 professionals starting side hustles, 1099 contractors ready to ‘upgrade’ their business, real estate LLCs, and especially high-income California owners concerned about state and federal tax harmonization. Let’s break down the dollar impact, compliance traps, and actionable moves you should make before the next return due date.

This information is current as of 12/4/2025. Tax laws change frequently. If reading this later, always verify updates with the IRS or FTB.

What’s S Corp and C Corp? Core Differences That Hit Your Wallet

The core difference comes down to how profits move through the company—and who pays tax, when:

• S Corp: Files Form 1120S. Profits (after a required “reasonable salary” to the owner) pass through to owners’ personal returns. No entity-level federal tax. Avoids double taxation. California S Corps pay a flat 1.5% franchise tax (min $800/year).
• C Corp: Files Form 1120. Corporation pays federal tax (21%) and California corporate income tax (8.84%). When profits are distributed as dividends, shareholders pay personal tax again—often at 15-23% federally (plus CA rates). This is double taxation.

BOTTOM LINE: If your business is profitable (> $60k) and you want to extract cash efficiently, S Corp keeps more dollars in owner pockets. If you plan to reinvest profits, offer equity to outside investors, or pursue big M&A moves, C Corp might serve better—if you’re strategic about it.

A smart way to approach whats s corp and c corp is to model the payroll impact over a 12-month cycle. S Corps allow owners to split income between W-2 wages and profit distributions, lowering exposure to Social Security and Medicare taxes, but only if the salary aligns with IRS “reasonable compensation” tests (Rev. Rul. 74-44). C Corps offer no such split—every dollar eventually flows through either payroll or dividend channels. If your profit margin is high and labor needs are low, the S Corp structure usually produces superior after-tax cash flow.

KDA Case Study: Tech Consultant Chooses S Corp Over C Corp—Saves $19,100 a Year

Linda, a Bay Area 1099 tech consultant earning $180,000, considered both S Corp and C Corp for her incorporated side business. She wanted to minimize taxes, remain audit-proof, and have payroll set up right from day one. Her previous CPA only discussed Form 1120 (C Corp)—but with KDA, she explored S Corp’s pass-through strategy:

• She established a California LLC, then filed IRS Form 2553 for S Corp election
• Set a reasonable W-2 salary of $90,000, leaving $70,000 as S Corp profit distribution
• Reduced self-employment and payroll taxes on the profit portion—saving $19,100 in the first year alone
• Ongoing annual fees: $800 CA minimum franchise, $600 in payroll service costs

Linda paid $4,000 for KDA’s entity structuring and ongoing payroll compliance. Her first-year ROI: 4.7x. She avoided the C Corp’s double tax hit, and now runs cleaner, lower-risk returns.

To truly understand whats s corp and c corp, analyze how each structure handles retained earnings. A C Corp can stockpile profits for future expansion with no immediate shareholder tax, which is why venture-backed or capital-intensive companies favor it. But California’s 8.84% corporate tax means those retained profits still face annual erosion. If your plan is long-term reinvestment—not owner distributions—the C Corp model can outperform an S Corp when properly capitalized and documented.

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.

Is an S Corp Always Better Than a C Corp for California Owners?

If you’re a high earner or Solo 1099, you may think S Corp is the automatic winner. Consider these realities:

• C Corp wins when: You want to attract outside investors, go public, or reinvest profits for years without taking large distributions
• S Corp wins when: You want to pull cash out yourself efficiently, or operate a business you own 100% or with a small partner group (especially family/LLC)

Example: A C Corp with $220,000 profit pays $46,200 in federal corporate tax. If the owner then takes $60,000 as a dividend, they pay an additional $9,000+ in personal taxes (not even including California taxes). Effective combined tax rate: nearly 36% on distributed cash.

With an S Corp strategy, the same $220,000 is split between salary and profit: salary is subject to payroll/SE tax, profit distributions are not—netting more take-home, provided you set a truly “reasonable” salary (not artificially low, or you’re IRS audit bait).

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

Red Flag Alert: Common S Corp and C Corp Mistakes

The IRS and California FTB look for these classic errors:

• Unreasonable S Corp salaries: Taking a $20,000 salary on $250,000 sales is a red flag—expect audit letters
• Late S Corp election: Missed the IRS 2553 deadline? Your LLC is stuck as a sole prop/partnership for the year—potentially costing $12K+ in SE tax
• C Corp double tax ignorance: New owners pulling dividends without planning for additional tax hit
• Mixing payroll accounts: Failing to set up proper W-2 and payroll tax filings for S Corp owners

This is fixable: Get help structuring your entity and payroll process from day one—include 1120S and 940/941 compliance checks.
Pro Tip: If you missed S Corp election deadline, IRS offers late relief if you act fast. See details in Form 2553 guidance.

Can Foreigners or Large Crews Use an S Corp?

S Corps have strict eligibility rules, especially in California:

A disciplined review of whats s corp and c corp must include shareholder restrictions, because they determine whether your long-term plan is even eligible for S Corp benefits. IRS rules (IRC §1361) prohibit foreign owners, multiple stock classes, and more than 100 shareholders—meaning many growth-focused or multi-investor firms must default to C Corp. Once you introduce foreign partners, option pools, or preferred shares, the S Corp election becomes invalid. Think of entity choice as a forward-looking tax decision, not just a savings tactic for this year.

• All shareholders must be U.S. citizens or permanent residents—no foreign owners allowed
• No more than 100 shareholders, and must generally be individuals (some trusts/estates qualify)
• C Corps and partnerships can’t be S Corp shareholders

If you plan to have non-U.S. owners or raise big venture rounds, you’re limited to C Corp. However, combined strategies exist for those with complex needs—sometimes using multiple entities.

What If You’re Already an LLC or Sole Proprietor?

You can switch your LLC to S Corp by filing Form 2553 (before the deadline in early March), provided you meet the S Corp rules. This election is reversible, though it comes with a five-year lock-in on flips between S and C status.

Red Flag: If you mistakenly think you have to “incorporate” again to make the switch, you’re creating paperwork headaches. Most LLCs can choose S Corp taxation with no new EIN or drastic legal changes.

Already operating as a sole proprietor? Now is the time to consider S Corp election for profits above $50,000—it’s the fastest route to legal self-employment tax reduction for solo professionals. Run your numbers in advance using this small business tax calculator.

What If Your Income Is Variable or Multistate?

S Corp is ideal for stable and increasing profits (think consulting, e-commerce, agencies). Variable or cyclical businesses with just one or two spikes may benefit from a hybrid: start as an LLC, then file S Corp election when profits justify payroll overhead. Multi-state operators: Know that S Corps must file franchise and income returns in each state they do business. The California S Corp franchise tax is unavoidable, but structure properly and you’ll still pay less overall compared to losing profits to double taxation.

FAQs: More S Corp vs C Corp Realities for 2025

Can I switch back from S Corp to C Corp?

You can, but there’s typically a 5-year waiting period before switching back unless certain IRS exceptions apply (IRS S Corp FAQ).

Does an S Corp help with California’s $800 minimum tax?

No. Both S Corp and C Corp entities pay at least $800/year to California. S Corps owe 1.5% on net income; C Corps pay 8.84%. Sole props avoid it, but lose bigger tax benefits.

If I want to offer stock options, do I have to choose C Corp?

Usually, yes—especially for tech and startups planning venture capital funding. S Corps are limited in ownership class and stock types.

Book Your Entity Strategy Session Before the Next Tax Year

Don’t leave thousands in the hands of the IRS or FTB. Book a 1:1 tax strategy session with a California entity expert—get side-by-side S Corp vs C Corp analysis, a clear implementation plan, and peace of mind all year. Click here to book your session now and finally take charge of your business structure.