The choice among an LLC, an S corporation, and a C corporation affects federal income tax, employment taxes, and California entity-level taxes. This overview compares how each is generally taxed for a California business. The best choice depends on the business’s income, plans, and owners, so projections based on actual numbers are worth running before deciding.
LLC With Default Tax Classification
Federal treatment. By default, a domestic LLC with one owner is disregarded for federal income tax purposes, and an LLC with two or more members is classified as a partnership (Treas. Reg. §301.7701-3(b)(1)). Either way, there is generally no federal income tax at the entity level; income and deductions pass through to the owners. A single-member LLC owned by an individual typically reports its business on Schedule C.
Self-employment tax. Owners who work in the business are generally subject to self-employment tax on their net earnings from self-employment. The rate is 15.3 percent: 12.4 percent for Social Security, which applies only up to the annual wage base ($184,500 for 2026, according to the Social Security Administration), and 2.9 percent for Medicare. An additional 0.9 percent Medicare tax applies above certain thresholds, such as $200,000 for single filers and $250,000 for married couples filing jointly. The employer-equivalent half of self-employment tax is deductible in computing adjusted gross income.
California treatment. An LLC doing business in California, or organized or registered with the California Secretary of State, generally owes the $800 annual tax each year until it is canceled, even if it is not conducting business. The first-year exemption that applied to LLCs formed in tax years 2021 through 2023 no longer applies. An LLC with total California income of $250,000 or more also owes an LLC fee: $900 for $250,000 to $499,999, $2,500 for $500,000 to $999,999, $6,000 for $1,000,000 to $4,999,999, and $11,790 for $5,000,000 or more. The owners pay California personal income tax on their share of the income.
S Corporation (Including an LLC That Elects S Status)
Federal treatment. An S corporation generally pays no federal income tax at the entity level. Its income, losses, and deductions pass through to its shareholders. An eligible LLC can elect S corporation status by filing Form 2553. An eligible entity that timely elects S status is treated as also electing to be classified as a corporation, so a separate Form 8832 is generally not required (Treas. Reg. §301.7701-3(c)(1)(v)(C)).
Employment taxes. A shareholder who works in the business is an employee. Wages are subject to Social Security and Medicare taxes and income tax withholding, while distributions of remaining profit are not subject to those employment taxes. This is the main source of potential savings compared with an LLC taxed under the default rules.
Reasonable compensation. According to the IRS, S corporations must pay reasonable compensation to a shareholder-employee for services provided before making non-wage distributions to that shareholder, and the IRS can recharacterize distributions as wages. Factors the IRS cites from court decisions include the shareholder’s training and experience, duties and responsibilities, time devoted to the business, compensation paid by comparable businesses for similar services, and dividend history.
Costs. An S corporation must run payroll, file quarterly and annual payroll returns, pay unemployment taxes on wages, and file a separate corporate return (federal Form 1120-S and California Form 100S). These costs offset part of any employment tax savings.
California treatment. California recognizes S corporation status. An S corporation pays a 1.5 percent franchise tax on its net income, subject to the $800 minimum franchise tax, and its shareholders pay California personal income tax on their share of the income.
C Corporation
Federal treatment. A C corporation pays federal income tax at a flat 21 percent rate (§11(b)). When it distributes earnings as dividends, shareholders are taxed again. Owners who work in the business are paid wages that are deductible to the corporation and subject to payroll taxes.
California treatment. California taxes corporations, other than banks and financial corporations, at 8.84 percent of net income, with an $800 minimum franchise tax. Newly incorporated or qualified corporations are generally not required to pay the minimum franchise tax for their first taxable year. Shareholders pay California personal income tax on dividends.
Possible advantages. A C corporation can retain earnings at the 21 percent federal rate, may be preferred by outside investors, and may issue stock that qualifies for the federal exclusion for qualified small business stock under §1202. For stock acquired after July 4, 2025, the exclusion is capped at $15 million and phases in at 50, 75, and 100 percent after three, four, and five years. Stock acquired earlier keeps the prior $10 million cap and five-year holding period.
The Qualified Business Income Deduction
Owners of businesses taxed as sole proprietorships, partnerships, or S corporations may be eligible for the federal §199A deduction of up to 20 percent of qualified business income, subject to limitations. The One Big Beautiful Bill Act made this deduction permanent. Reasonable compensation an S corporation pays to its owner is not qualified business income, and C corporation income does not qualify.
An S corporation’s potential advantage comes mainly from employment taxes: wages are subject to Social Security and Medicare taxes, while distributions above reasonable compensation are not. That advantage must be weighed against payroll costs, California’s 1.5 percent tax on S corporation income, and the effect on the QBI deduction.
Comparing the Structures
An LLC with default classification is the simplest to operate but exposes all of an active owner’s net earnings to self-employment tax. An S corporation can reduce employment taxes when profits meaningfully exceed a reasonable salary, at the cost of payroll administration and an additional state-level tax. A C corporation adds a second layer of tax on distributed earnings, which may be acceptable for a business that plans to retain earnings, raise outside capital, or qualify for the §1202 exclusion.
The Bottom Line
No single structure is right for every business. The comparison depends on expected profit, a defensible salary level, whether earnings will be distributed or retained, future sale or investment plans, and the state-level costs described above. Running projections with actual figures before forming an entity or making an election is the most reliable way to compare the options.
Choosing a business structure?
Tax attorney Cassra Minai, Esq. can review your situation in a confidential consultation.