Key Takeaways

  • Both LLCs and S Corporations offer limited liability protection, but differ in ownership, taxation, and management structure.
  • In California, both entities must pay the $800 annual franchise tax, but LLCs may also owe a gross receipts fee.
  • S Corps are often more tax-efficient for owners drawing a salary and dividends, while LLCs offer simpler management and flexible profit distribution.
  • California imposes additional filing requirements for S Corps, including electing S status at both the federal and state level.
  • LLCs are more flexible for small or single-member businesses, while S Corps may benefit established businesses planning for growth and outside investors.

S Corporation vs C Corporation

S corporation vs C corporation is a common comparison for individuals interested in starting a business. One of the first things a business owner needs to do to get their business running is decide what business structure, or business entity, they want to have. There are a number of business entities to choose from, each with its own advantages and disadvantages. Business owners should always consult with professionals, such as a business attorney and an accountant, before coming to a final decision.

One option business owners have is to incorporate. By forming a corporation, a business owner creates a legal entity that is totally legally separate from the individual owners. This is important for personal liability and tax purposes.

Corporations can only be formed by filing Articles of Incorporation with the state government in which the corporation will be headquartered. For most states, this filing must go to the Secretary of State.

Corporations are owned by shareholders that are legally distinct from the corporation itself. Therefore, shareholders are not personally liable for the debts and liabilities of the corporation.

The traditional corporation is called the C corporation. This type of corporation allows for an unlimited number of shareholders, and is ideal for businesses that are planning on growing and are actively seeking more investors. C corporations also offer more flexible stock options and profit sharing structures than other entities. They can also carry losses or profits into following years, which can reduce tax burdens and keep earnings in the business.

Finally, C corporations are ideal for business owners that plan on selling their interest in the business, because stock ownership is fully transferrable.

The primary downside to C-corporations is that they are taxed and shareholders are taxed when they receive dividends. This results in “double taxation” on corporate profits. Because of double taxation, many smaller businesses find the C corporation entity form untenable.

Comparing S Corp vs LLC in California

When deciding between an S Corporation and a Limited Liability Company (LLC) in California, business owners should understand how state tax rules, management flexibility, and ownership structures differ. While both entities protect owners from personal liability, California imposes unique state-specific taxes and filing obligations that can influence your decision.

1. California Taxes and FeesEvery business entity operating as an S Corp or LLC in California must pay the $800 annual franchise tax. However, LLCs must also pay a gross receipts fee if annual revenue exceeds $250,000 — a charge that does not apply to S Corporations. This additional fee can make S Corps more appealing for higher-earning businesses.

2. Ownership and ComplianceS Corporations in California can have up to 100 shareholders, all of whom must be U.S. citizens or residents, and can only issue one class of stock. In contrast, LLCs have no restrictions on the number or type of members — they can include individuals, corporations, or even other LLCs.

Forming an S Corporation also requires filing IRS Form 2553 for federal election and California Form 3560 for state recognition. LLCs are formed by filing Articles of Organization (Form LLC-1) with the California Secretary of State and drafting an Operating Agreement.

3. Management FlexibilityLLCs offer flexibility in management — members can manage the company themselves or appoint managers. S Corporations, however, require a board of directors, officers, and formal corporate governance practices, such as annual meetings and recordkeeping.

4. Self-Employment TaxesFor tax purposes, LLC members typically pay self-employment tax on all profits, while S Corp shareholders who work in the business can draw a “reasonable salary” and take additional profits as distributions. These distributions are not subject to self-employment tax, potentially reducing overall tax liability.

5. Suitability

  • LLCs are generally preferred by small businesses, freelancers, and startups seeking operational flexibility and simpler compliance.
  • S Corporations are ideal for businesses with steady profits, employees, and plans for long-term growth or investment.

Choosing between an S Corp and LLC in California ultimately depends on how you plan to manage profits, attract investors, and handle administrative requirements.

What is an S Corporation

The S corporation is an entity that is able to avoid double taxation. If certain requirements are met, a corporation can file for S corporation status with the IRS. Forming an S corporation also requires a filing of Articles of Incorporation.

S corporations are still a separate legal entity from the shareholders that own it, but the business profits and losses “pass through” the entity and go directly to the shareholders. Therefore, the corporation itself does not pay any taxes, and shareholders instead report corporate profits on their own tax returns.

There are requirements that must be met for a business to qualify as an S corporation, but if these requirements are met, an S corporation has much more flexibility in its internal accounting. Many business owners choose the S corporation because there is a lower chance of an IRS audit than with C corporations. This is because the S corporation must file an information tax return, called Form 1120, which reduces the audit rate for S corporations. C corporations can be converted into S corporations.

Because S corporations are not double taxed, many owners choose this entity to save on taxes. But, any shareholders that are also employees must pay a self-employment tax on the salary they take from the corporation. S corporations, despite having similarities with less complicated LLCs, still have many of the strict requirements of traditional corporations have. Therefore, setting up and maintaining an S corporation isn’t necessarily cheaper than a traditional C corporation.

California S Corp Requirements and Benefits

To operate as an S Corporation in California, a business must first form a standard corporation and then elect S status by filing Form 2553 with the IRS and Form 3560 with the California Franchise Tax Board.

Eligibility Requirements Include:

  • No more than 100 shareholders.
  • Shareholders must be U.S. citizens or residents.
  • Only one class of stock may be issued.
  • All shareholders must consent to the S election.

Tax Benefits:S Corporations are “pass-through” entities, meaning business income is reported on each shareholder’s personal tax return, avoiding double taxation. In California, however, S Corps pay a 1.5% state income tax on net income, in addition to the $800 annual franchise tax.

Other Advantages:

  • Easier to attract investors than an LLC due to stock issuance.
  • Potential savings on self-employment tax through reasonable salary and dividend distributions.
  • Credibility with clients and lenders from a more formal corporate structure.

Similarities between S Corp and C Corp

S corporations and C corporations both offer owners protection from individual liability. They are both separate legal entities and both require a filing of Articles of Incorporation with the state. Both are shareholder owned, have a Board of Directors, and typically are managed by executive officers.

The Board of Directors of a corporation oversees the major decisions and determines the broader strategies of the corporation. The executive officers, who are elected by the Board of Directors, manage the day-to-day affairs.

Both S corporations and C corporations are required to have the same formal filings, annual meetings, and must pay annual fees. Both must have Bylaws, issue stock, and are usually required to have a Board of Directors.

Differences between S Corp and C Corp

The most significant difference between a C corporation and an S corporation is that S corporations are not taxed as separate entities.  C corporations must file a corporate tax return and pay taxes at the corporate level. When profits are distributed to shareholders, the shareholders must also pay taxes on those profits on their personal income taxes. S corporations do not pay taxes (although they still must file an income tax return). Corporate profits are taxed when they are distributed to shareholders as personal income.

S corporations cannot be owned by more than 100 individuals, and can only be owned by natural individuals (not by other corporations, LLCs, trust, or any other artificial entities). S corporations can only be owned by United States citizens or resident aliens. C corporations can be owned by any other legal entity, foreign or domestic.

C corporations can have multiple classes of stock and various different profit sharing structures, but S corporations are required to only have one class of stock. Because C corporations are less restricted with regards to stocks, it is usually easier to attract investors and grow a company if it is a C corporation.

What is a Limited Liability Company

A Limited Liability Company (LLC) is a modern alternative to the corporation. An LLC is not incorporated, so the advantages of offering public stock are not available. However, LLCs are much more flexible in how they can be managed, do not take as much time and money to maintain, and still insulate individual owners (“Members”) from personal liability for company losses.

They are also often a good choice for tax purposes as they are, like the S corporation, a “pass through” entity that avoids double taxation. LLCs are by default not taxable entities, and Members pay for LLC profits on their individual tax returns.

LLCs are formed by filing Articles of Organization with the state. There are fewer formal requirements and fees needed to set-up and maintain an LLC than a corporation. However, some states levy additional taxes on LLCs (California for instance has a “franchise tax” that applies to LLCs).

LLCs are preferred by those that want to pass the profits and losses on directly to the owners. They are also more flexible in terms of how they can be managed. There is no requirement that LLCs have a Board of Directors of Bylaws. Some states do require an Operating Agreement, and most LLCs should have an Operating Agreement regardless of whether it is required by law. LLC Members can opt to manage the LLC themselves, or they can hire others to do so for them.

There are fewer formalities with an LLC. Many small business owners prefer them for this reason. There are no annual meetings, Board meetings, or record keeping requirements as with corporations.

LLCs in California: Costs and Flexibility

Forming an LLC in California requires filing Articles of Organization (Form LLC-1) and paying a $70 filing fee, along with an annual Statement of Information (Form LLC-12). Every LLC must also pay the $800 annual franchise tax, plus an additional gross receipts fee for income above $250,000, which scales up to $11,790.

Advantages of a California LLC:

  • Flexible profit allocation not tied to ownership percentage.
  • Simpler internal structure with fewer formalities than corporations.
  • Protection from personal liability for business debts.
  • Option to elect S Corporation tax treatment later for potential savings.

Drawbacks:

  • Potential for higher total taxes due to California’s gross receipts fee.
  • Members pay self-employment tax on all earnings unless S Corp status is elected.

For small businesses focused on simplicity and flexibility, an LLC may be a more practical choice. However, for profitable, employee-heavy operations, S Corp status can yield tax advantages.

Frequently Asked Questions

1. Is it better to form an S Corp or LLC in California? It depends on your business goals. LLCs offer simplicity and flexibility, while S Corps may provide tax advantages for higher-income owners who can take distributions instead of self-employment income.

2. What taxes do both LLCs and S Corps pay in California? Both pay the $800 annual franchise tax. S Corps also pay a 1.5% tax on net income, while LLCs pay a gross receipts fee based on revenue.

3. Can a California LLC be taxed as an S Corporation? Yes. An LLC can elect to be taxed as an S Corporation by filing IRS Form 2553 and California Form 3560, allowing it to potentially reduce self-employment taxes.

4. Are S Corps more complicated to manage than LLCs? Yes. S Corps require formal meetings, bylaws, and recordkeeping. LLCs are easier to manage and allow for more informal operations.

5. Which is cheaper to maintain: an LLC or S Corp? For smaller businesses, LLCs often cost less to maintain. However, for profitable companies, an S Corp may provide overall tax savings that outweigh the higher compliance costs.

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