TL;DR — Key Takeaways

• An LLC and an S corp are different things in California. An LLC is a legal entity; an S corp is a tax election. An LLC can elect to be taxed as an S corp.
• S corp tax treatment lets owners pay themselves a reasonable salary (subject to payroll taxes) and take additional profit as distributions (not subject to self-employment tax). The savings come from the second part.
• S corp benefits typically start to outweigh the costs around $80,000-$100,000 in net business income. Below that, the added complexity often costs more than the tax savings.
• California LLCs pay an $800 minimum franchise tax plus a gross receipts fee on revenue over $250,000. California S corps pay the greater of $800 or 1.5% of net income. The state-level math doesn’t favor S corps the way the federal math does.
• S corps have ownership restrictions: 100 shareholder limit, no foreign owners, only one class of stock, and no entity owners with limited exceptions.

Can a California LLC Elect S Corporation Tax Treatment?

Yes. A California LLC can file IRS Form 2553 to elect S corp tax treatment for federal purposes, and California recognizes the election for state purposes by default if certain conditions are met. The LLC remains a legal LLC but is taxed as an S corp.

The election doesn’t change the entity. The LLC continues to file its Statement of Information, maintain an operating agreement, and operate under California’s LLC laws. What changes is how income is taxed and how the owner pays themselves.

The election deadline is generally within 75 days of the start of the tax year for which you want it to apply, or within 75 days of forming the LLC. Late elections are possible under IRS Rev. Proc. 2013-30 with reasonable cause.

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How Does S Corp Tax Treatment Save Money Compared to an LLC?

The savings come from self-employment tax — specifically, the 15.3% combined Social Security and Medicare tax on self-employment income.

Default LLC taxation (single-member or multi-member). The owner pays self-employment tax on all net business income, up to the Social Security wage base ($168,600 for 2024, indexed annually). Above the wage base, only the 2.9% Medicare portion (plus 0.9% Additional Medicare Tax for high earners) applies.

S corp taxation. The owner is treated as an employee. They pay themselves a reasonable salary, on which payroll taxes apply (FICA at 7.65% for the employee plus 7.65% paid by the entity, totaling 15.3%). The remaining profit is distributed to the owner without self-employment tax.

The math. A consulting LLC with $200,000 net income pays roughly $20,000 in self-employment tax (Social Security on first $168,600 plus Medicare on the rest). The same business as an S corp paying the owner $100,000 in salary and $100,000 in distributions pays roughly $15,300 in payroll tax on the salary, with no self-employment tax on the distribution. Savings: about $4,700 per year. The savings scale with income.

Do Both LLCs and S Corps Pay the $800 California Franchise Tax?

Yes. Both California LLCs and S corps pay the $800 minimum annual franchise tax to the FTB. The structure of the tax differs.

California LLC. $800 minimum franchise tax. Plus a gross receipts fee starting at $900 for LLCs with California-source gross receipts over $250,000, scaling up: $2,500 at $500,000+, $6,000 at $1,000,000+, $11,790 at $5,000,000+. [VERIFY: confirm current LLC fee schedule under R&TC § 17942.]

California S corporation. Pays the greater of $800 or 1.5% of net income. No gross receipts fee. The 1.5% rate applies to California-source net income.

Comparison. For a high-revenue, low-margin business, the LLC gross receipts fee can exceed the S corp’s 1.5% net income tax. For a high-margin business, the S corp’s 1.5% on net income often costs more than the LLC fees.

Run both calculations before electing. The FTB publishes worksheets and an online calculator. Most CPAs do this analysis as part of entity selection.

What Are the Ownership Restrictions for an S Corporation?

S corp eligibility requires meeting specific federal restrictions. An LLC that elects S corp status has to comply with these rules just like a corporation that’s an S corp.

100 shareholder limit. The entity can have no more than 100 shareholders. Family members can be counted as one shareholder under specific rules.

Eligible shareholders only. Shareholders must be U.S. citizens or residents, certain trusts and estates, or specific exempt organizations. Non-resident alien shareholders disqualify the election.

One class of stock. S corps can have only one class of stock with respect to distribution and liquidation rights. Voting rights can vary, but economic rights cannot. This rules out preferred stock, profit-sharing arrangements that aren’t proportional to ownership, and most VC investment structures.

No corporate or partnership shareholders (with exceptions). Only individuals, qualifying trusts, and estates can hold S corp shares. Wholly-owned subsidiaries can be set up under specific rules (QSubs).

If your business needs flexibility on these — multiple owner classes, foreign investors, complex equity structure — an S corp will be a poor fit.

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When Does It Make Sense to Switch From LLC to S Corp Status in California?

The threshold question is whether the self-employment tax savings exceed the added complexity and costs.

Costs of S corp status. Reasonable salary requirements (you can’t pay yourself zero salary just to avoid payroll tax — the IRS will recharacterize), payroll setup and quarterly tax filings, separate corporate tax return (Form 1120-S federal, Form 100S California), workers’ compensation insurance covering the owner-employee, additional CPA fees (typically $1,500-$3,000 more per year), and the California 1.5% state-level S corp tax.

The break-even. For most California businesses, the math starts working in favor of S corp election around $80,000-$100,000 in net business income. Below that, the added costs eat the federal SE tax savings. Above that, the savings grow steadily.

When not to elect. Service businesses with high revenue but tight margins (where the $800 minimum is the binding constraint), businesses planning to raise venture capital (S corp election will be revoked at conversion), businesses with foreign owners, and businesses with active losses (S corp passes losses through, but loss limitation rules differ from LLCs).

Mid-year considerations. If you’re forming a new business, you can elect S corp status from inception by filing Form 2553 within 75 days. If you have an existing LLC, you can elect from the start of the next tax year, or retroactively to the start of the current year if you file by the deadline.

What “Reasonable Salary” Means for an S Corp Owner

The IRS requires S corp owner-employees to receive reasonable compensation for services performed. Paying yourself zero salary while taking large distributions is a common audit trigger.

Reasonable salary is determined by what you would pay someone else to perform your role, considering factors like industry, geographic location, skills, hours worked, and the company’s profitability. The IRS has guidance and case law defining the standard, but there’s no fixed formula.

Common rules of thumb practitioners use: 30%-50% of net business income for active service businesses, with adjustments based on the owner’s actual time and contribution. A heavily passive business (real estate holdings, royalty income) can support a lower salary because the owner isn’t actively producing the income.

Document your reasoning. Keep records of comparable compensation, hours worked, and rationale for the salary level. The documentation matters more than the specific number when the IRS reviews.

Call (650) 668-8000 or schedule a consultation at baylegal.com/contact.

This article is for informational purposes only and does not constitute legal advice. California real estate law is complex and changes frequently. Contact Bay Legal, PC to discuss your specific situation.

Frequently Asked Questions

Should I elect S corp status for my California LLC?

Generally yes if your net business income is consistently above $80,000-$100,000 and you’re not planning to raise venture capital. Below that threshold, the added complexity often outweighs the federal tax savings.

Can my California LLC be taxed as an S corp?

Yes. File IRS Form 2553 to elect S corp treatment. The LLC remains an LLC legally but is taxed as an S corp.

Does California recognize the federal S corp election?

Yes, California generally recognizes the federal S election by default. California S corps still pay the 1.5% state-level S corp tax (or $800 minimum, whichever is higher).

How much do I need to make to benefit from S corp status?

Generally above $80,000-$100,000 in net business income. The break-even depends on your reasonable salary, payroll tax rates, and added compliance costs.

Can I undo an S corp election?

Yes. You can voluntarily revoke the election or terminate it. The five-year reversal rule limits how soon you can re-elect after termination.