Most California business owners choose their entity structure the same way they pick a cell phone plan — they pick whatever sounds reasonable and move on. That decision quietly costs them thousands every single year. What’s the difference between S Corp and a C Corp is one of those questions that sounds simple but carries a $10,000 to $31,000 annual price tag depending on which answer you act on — or ignore.

Here’s the real problem: most business owners are operating as the wrong entity type right now. They either formed a C Corp because it sounded official, or they stayed as a default LLC with no tax election because their accountant never brought it up. Either path leaves serious money on the table in 2026, especially in California where the state adds its own layer of franchise tax complexity on top of whatever the IRS expects.

This guide breaks down the actual difference between these two structures — what they cost you in taxes, when each one makes sense, and what you need to do before it’s too late to make the switch this year.

Quick Answer

An S Corp passes all business income directly to shareholders who report it on their personal returns — no corporate-level tax. A C Corp pays its own taxes at the corporate rate, and then shareholders pay again when they receive dividends. That second layer of taxation is the core difference, and it’s why most small business owners in California are better served by an S Corp election once their net profit exceeds $60,000 annually.

How Each Structure Is Actually Taxed

The tax treatment between these two entity types is fundamentally different, and the gap compounds fast as your business grows.

S Corp: Pass-Through Taxation

An S Corporation is a pass-through entity. That means the business itself does not pay federal income tax. Instead, profits and losses flow through to the shareholders’ personal tax returns — proportional to their ownership percentage. If you own 100% of an S Corp that earns $150,000 in net profit, that $150,000 shows up on your Form 1040, not on a separate corporate return.

What makes this particularly valuable for working business owners is the self-employment tax savings. When you operate as a sole proprietor or single-member LLC, every dollar of net profit is subject to the 15.3% self-employment tax (Social Security and Medicare). With an S Corp, you pay yourself a “reasonable salary” — say $65,000 — and only that salary is subject to payroll taxes. The remaining $85,000 in profit passes through as a distribution, completely exempt from self-employment tax. On $85,000, that’s roughly $13,000 saved in SE tax alone.

For a complete breakdown of how to structure your S Corp salary and maximize this strategy in California, see our comprehensive S Corp tax strategy guide.

C Corp: Double Taxation Is the Default

A C Corporation is a separate taxable entity. It files its own return (Form 1120) and pays the flat 21% federal corporate tax rate on its net income. When those after-tax profits are distributed to shareholders as dividends, shareholders pay again — at qualified dividend rates between 15% and 20% depending on their income level, plus the 3.8% Net Investment Income Tax for high earners.

Do the math on a $150,000 profit: the C Corp pays $31,500 in federal corporate tax, leaving $118,500. If that’s distributed as dividends to a moderate-income owner, they’ll pay another $17,775 in dividend tax. Total federal tax burden: $49,275. Compare that to an S Corp owner who might pay $24,000 to $28,000 in combined income and payroll taxes on the same profit. The C Corp costs an additional $21,000 to $25,000 per year. Every year.

California Adds Another Layer

California does not conform to federal S Corp treatment automatically. You must separately elect S Corp status with the California Franchise Tax Board using FTB Form 3560. California taxes S Corp income at 1.5% at the entity level (minimum $800), while C Corps face the state’s 8.84% franchise tax on net income — one of the highest state corporate tax rates in the country.

For California business owners earning $200,000 or more in net profit, the state-level tax difference between an S Corp and C Corp can add another $14,000+ to their annual bill.

KDA Case Study: Freelance Engineer Switches to S Corp and Saves $18,400

Marcus is a software engineer in San Jose who left his W-2 job in 2023 to consult independently. He set up a single-member LLC and spent his first two years paying self-employment tax on every dollar he earned. By 2025, his LLC was netting $185,000 annually — and he was handing over $28,275 in SE tax in addition to his regular income tax bill.

When Marcus came to KDA, our team ran the numbers. By electing S Corp status via Form 2553 and setting his reasonable salary at $85,000 (consistent with market rates for his experience and role), his SE tax dropped to $12,981 — a savings of $15,294 on SE tax alone. After accounting for the additional cost of payroll administration and his California FTB election, his net first-year savings landed at $18,400.

Marcus reinvested that savings into a SEP-IRA contribution, which created an additional $6,440 in federal tax savings — turning one structural change into a compounded tax advantage. His total ROI on KDA’s advisory fee was 4.1x in year one.

If you’re an independent consultant, contractor, or self-employed professional earning more than $60,000 in net profit, this exact strategy is likely available to you right 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.

When an S Corp Makes More Sense Than a C Corp

The S Corp is the right structure for the vast majority of small and mid-size California business owners. Here’s when it clearly wins:

• Net profit between $60,000 and $500,000 annually — This is the sweet spot where the self-employment tax savings are substantial but the business isn’t complex enough to need C Corp features.
• Single-owner or small partnership businesses — S Corps can have up to 100 shareholders, all of whom must be U.S. citizens or permanent residents.
• No plans to reinvest large profits at the corporate level — If you’re going to distribute most of the profit to yourself, pass-through taxation is the more efficient structure.
• No desire to issue preferred stock or multiple stock classes — S Corps can only have one class of stock, which works perfectly for most owner-operated businesses.
• Professional services, consulting, and freelancing — These businesses often have minimal overhead and high profit margins, making SE tax savings especially large.

Want to see exactly how much an S Corp election could save your specific business? Run your annual profit through this small business tax calculator to estimate your current vs. post-election tax burden.

When a C Corp Actually Wins

The C Corp gets a bad reputation from the double taxation problem, but it’s genuinely the right structure in specific situations. Forcing an S Corp election in these cases would actually cost more, not less.

Venture-Backed Startups

Venture capital firms almost universally require their portfolio companies to be structured as Delaware C Corps. The reason is simple: C Corps can issue multiple classes of stock (common and preferred), which is essential for a typical VC deal structure. If you’re building a company with the intent to raise institutional capital or pursue an IPO, a C Corp is not just preferable — it’s functionally mandatory.

High-Profit Businesses with Reinvestment Plans

The 21% flat federal corporate tax rate is actually lower than the top individual rate of 37%. If your business routinely earns $600,000 or more and you plan to reinvest most of that profit back into the company rather than distribute it, a C Corp can defer taxation on retained earnings more efficiently. The double taxation problem only materializes when dividends are paid. If you’re holding profits inside the corporation to fund expansion, equipment, or hiring, the C Corp can be the more efficient structure for large-scale operators.

International Shareholders or Foreign Investors

S Corps cannot have non-U.S. citizen shareholders. If your business has or plans to have international investors or partners, the C Corp is the only option. This comes up frequently in tech, manufacturing, and import/export businesses.

Qualified Small Business Stock (Section 1202)

C Corp shareholders may qualify for the Section 1202 exclusion under IRS Publication 550, which allows an exclusion of up to 100% of capital gains on the sale of Qualified Small Business Stock (QSBS) — potentially tax-free. This exclusion is only available for C Corp stock. For founders planning an eventual exit, this provision alone can be worth millions in tax-free appreciation.

The Most Common Mistake: Staying a Default C Corp by Accident

Here’s a trap that catches California business owners constantly: when you incorporate a business in California, the default entity type is a C Corporation. If you never filed Form 2553 with the IRS to elect S Corp taxation, you are being taxed as a C Corp right now — even if you never intended that. This happens most often when founders incorporate through online legal services that walk them through state formation but say nothing about federal tax elections.

The IRS allows late S Corp elections in certain circumstances under Revenue Procedure 2013-30, but the window has rules. If you’ve been operating as a C Corp unintentionally and want to switch, you typically need to file by March 15 of the first year you want the election to be effective. Miss that window and you’re waiting another full year.

Red Flag Alert: If you formed a corporation and your accountant has been filing Form 1120 (C Corp return) instead of Form 1120-S (S Corp return) without explaining why, it’s worth asking whether you’re in the right entity structure — or stuck in one you never chose.

What’s the Difference Between S Corp and a C Corp on Your Tax Return?

The documentation requirements are also meaningfully different between the two structures.

S Corp Tax Filing Requirements

• File Form 1120-S annually (federal S Corp return) by March 15 or with extension
• Issue Schedule K-1 to each shareholder showing their portion of income, deductions, and credits
• File Form 3560 with the California FTB for state S Corp election
• Run payroll for any shareholder-employee (W-2 required; no owner draws without payroll)
• Pay California franchise tax: 1.5% of net income, minimum $800

C Corp Tax Filing Requirements

• File Form 1120 annually (C Corp return) by April 15 or with extension
• Pay quarterly estimated taxes at the corporate level
• File California Form 100 for state franchise tax (8.84% rate)
• Maintain corporate minutes, resolutions, and formal board documentation
• Issue Form 1099-DIV to shareholders who receive dividends

Both structures require more administrative overhead than a simple sole proprietorship or single-member LLC. That’s a real cost — payroll software, additional tax filings, and potentially more CPA time. Factor this into your net savings calculation. For most business owners earning over $75,000 in net profit, the administrative costs are easily offset by the tax savings.

Our tax planning services include entity optimization analysis that runs the actual numbers for your business — accounting for your profit level, California-specific costs, and payroll administration fees — before recommending any structural change.

How to Convert From a C Corp to an S Corp in 2026

If you’ve determined that an S Corp election is right for you, here’s exactly how to make the switch:

1. Verify eligibility: Confirm your corporation has fewer than 100 shareholders, all are U.S. citizens or permanent residents, and you only have one class of stock outstanding.
2. Obtain consent from all shareholders: Every shareholder must sign a consent form agreeing to the S Corp election. This is required by the IRS even if you are the sole owner.
3. File Form 2553 with the IRS: Submit the election form no later than March 15 of the tax year you want it to take effect. Download the current version directly from IRS.gov.
4. File FTB Form 3560 in California: Within 60 days of your federal election, submit the California S Corporation Election form to the Franchise Tax Board. California will not honor your federal election without this separate state filing.
5. Set up payroll: Once your election is approved, you must begin paying yourself a W-2 salary. Use a payroll platform or work with your CPA to determine your reasonable compensation amount based on your industry and role.
6. Watch for Built-In Gains (BIG) tax: If your C Corp had appreciated assets at the time of conversion, those gains may be subject to the Built-In Gains tax under IRC Section 1374 if recognized within 5 years of the election. Get this reviewed before filing.

Frequently Asked Questions

Can an LLC be taxed as an S Corp or C Corp?

Yes. An LLC is a state-level legal structure, but the IRS allows LLCs to choose their federal tax classification. A single-member LLC can elect to be taxed as a sole proprietorship (default), C Corp (Form 8832), or S Corp (Form 2553). Multi-member LLCs default to partnership taxation but can also elect corporate treatment. This flexibility makes the LLC one of the most powerful vehicles for tax planning when paired with the right election.

Is there a deadline to switch from C Corp to S Corp?

Yes. To have your S Corp election effective for the 2026 tax year, you must file Form 2553 no later than March 15, 2026. If you miss this deadline, the election will be effective for tax year 2027. California’s FTB Form 3560 must be filed within 60 days of the federal election date. Late elections are sometimes accepted under IRS Rev. Proc. 2013-30, but you must demonstrate reasonable cause for the delay.

Will switching to an S Corp trigger an IRS audit?

Not automatically. The IRS monitors S Corps primarily for unreasonably low salaries — where the owner pays themselves a below-market wage to minimize payroll taxes. If you set a reasonable salary based on industry benchmarks and document your rationale, an S Corp election is a completely legitimate and IRS-approved tax planning strategy. The key is having documentation that supports your salary decision. According to IRS S Corp compensation guidelines, reasonable compensation is evaluated based on training, experience, duties, and comparable wages in your field.

Do S Corp shareholders pay self-employment tax on distributions?

No. That’s the core advantage. Distributions from an S Corp to shareholders are not subject to self-employment tax. Only the W-2 salary you pay yourself is subject to payroll taxes (Social Security and Medicare). This is why setting a defensible but modest reasonable salary is the central S Corp tax strategy for most business owners.

What happens to a C Corp’s retained earnings if it converts to S Corp?

Retained earnings accumulated while the business was a C Corp become “Accumulated Earnings and Profits” (AE&P). These earnings remain subject to special rules even after the conversion. If they are distributed, they may be taxable as dividends to shareholders — even though you’re now an S Corp. This is a critical planning issue that requires careful handling during any C-to-S conversion. Do not attempt this conversion without professional guidance.

The Bottom Line: Which One Is Right for You?

Most California business owners earning between $60,000 and $500,000 in annual net profit will save more taxes as an S Corp than as a C Corp. The math is clear, the IRS explicitly allows the election, and the administrative burden is manageable with proper support.

C Corps make sense for venture-backed startups, businesses with international shareholders, companies holding significant appreciated assets, and owners planning exits who want to qualify for the Section 1202 QSBS exclusion.

If you’ve been operating as a C Corp — either intentionally or by default — and you haven’t had a tax professional run a real comparison for your specific income level and California tax situation, that analysis is overdue. The difference between the right and wrong structure is often $10,000 to $31,000 per year. Compounded over five years, that’s a six-figure mistake.

Key Takeaway: The difference between S Corp and C Corp taxation is not a technicality — it is a structural decision that directly determines how much of your business income you keep. Make the right choice before the March 15 election deadline.

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

Stop Overpaying — Book Your Entity Optimization Session Today

If you’ve been running your business as a C Corp, default LLC, or any structure your attorney set up years ago without a tax-strategy lens, you are almost certainly leaving thousands on the table. Our team at KDA runs a detailed entity comparison analysis for every new client — looking at your specific income, California franchise tax exposure, payroll costs, and self-employment tax savings — before recommending any change. You get clarity, not guesswork. Click here to book your tax strategy consultation now.