"Should I form an LLC or an S-corp?" is the most common question in California business formation — and it is slightly the wrong question. An LLC is an entity; an S-corp is a tax status that either an LLC or a corporation can elect. Getting the combination right can save real money every year. Here is how the pieces fit.
Start with the right frame: entity vs. tax election
You form an entity with the California Secretary of State: a limited liability company or a corporation. Separately, you choose how the IRS taxes it. A single-member LLC is taxed as a sole proprietorship by default; a multi-member LLC as a partnership; a corporation as a C-corp. Either can file IRS Form 2553 and elect S-corporation status if it qualifies — generally no more than 100 shareholders, only eligible shareholders such as U.S. citizens or resident aliens, certain trusts, estates, and tax-exempt organizations, and one class of stock. So the real choices are: LLC taxed by default, LLC taxed as an S-corp, or corporation taxed as an S-corp.
What California charges each structure
California's Franchise Tax Board takes a bite either way, but the formulas differ:
- California LLCs generally pay an $800 annual tax. Corporations generally pay an $800 minimum franchise tax, although the minimum does not apply to a newly incorporated or qualified corporation in its first taxable year.
- LLCs (default taxation) also pay a fee under Revenue and Taxation Code § 17942 once total California income reaches $250,000 — $900 at that level, scaling to $11,790 for income of $5 million or more. Note that this is based on total income, generally approximating gross receipts, not net profit: a high-revenue, thin-margin LLC pays it even in a break-even year.
- S-corps (whether a corporation or an LLC that elected S status) instead pay California a 1.5% tax on net income, generally with an $800 minimum.
The crossover math is worth running with your CPA: a services business with $600,000 in revenue and high margins may pay less California entity-level tax as a default-taxed LLC; the same revenue at low margin may favor the S-corp (the 1.5% applies to profit, the § 17942 fee to total income). The bigger federal variable is next.
The self-employment tax angle
For a profitable owner-operated business, the main reason S-corp status exists in conversation is self-employment tax, generally 15.3% up to the Social Security wage base, with Medicare tax continuing above it. A default-taxed LLC owner generally pays self-employment tax on the business's entire net earnings. With an S-corp election, the owner takes a reasonable salary subject to payroll taxes, and remaining profit passes through without being subject to self-employment tax. On, say, $200,000 of profit with a defensible $110,000 salary, the savings are meaningful — but "reasonable salary" is an IRS enforcement priority, and the election adds payroll processing, a separate tax return, and accounting costs that often make sense only above roughly $75,000–$100,000 of consistent profit. This is a decision to make with both your attorney and your tax professional.
Non-tax differences that matter
- Formalities. LLCs are lighter: no required board, no annual shareholder meetings, and a flexible operating agreement. Corporations require bylaws, directors, minutes, and stock records — plus an annual Statement of Information, whereas LLCs file biennially.
- Ownership flexibility. S-corp rules prohibit most entity and foreign shareholders and require one class of stock. If you expect investors, profit-sharing tiers, or a foreign co-owner, S status may be off the table regardless of entity type.
- Professional services. California restricts LLCs from rendering services that may lawfully be rendered only under a professional license unless the applicable licensing law authorizes an LLC. Lawyers, doctors, accountants, and other licensed professionals must confirm which entity forms their licensing rules permit; a professional corporation is often the appropriate choice.
- Investors. Venture-backed startups almost always need a C-corporation (often Delaware), not an LLC or S-corp, because investment funds generally cannot hold S-corp stock, and S-corps cannot issue preferred shares.
A practical decision path
- New business, modest or uncertain profit → an LLC taxed by default keeps things simple and cheap.
- Owner-operated business clearing six figures in profit → keep the LLC and elect S-corp taxation, or form a corporation with an S election; run the § 17942 fee vs. 1.5% comparison.
- Licensed professional → use an entity permitted by the applicable licensing rules, often a professional corporation, typically with an S election if eligible.
- Raising venture capital → Delaware C-corp.
Whichever route fits, form it correctly: articles, a real operating agreement or bylaws, required filings, and clean separation of finances. Our business formation practice sets up California entities with the tax election and governance documents matched to your actual plans — and coordinates with your CPA rather than guessing at the numbers.
Talk to a California business attorney
Choosing between an LLC and an S-corp is cheaper to get right the first time than to fix later. Itkin Law can walk you through the choice and form the entity properly. Schedule a free consultation or call (949) 418-2113.
This article is attorney advertising and provides general information only. It is not legal advice and does not create an attorney–client relationship. Facts matter; consult a lawyer about your specific situation.
