The S-Corp vs. LLC question is one of the most common ones I hear from business owners and self-employed professionals in San Diego. The answer matters — and in California, it's more nuanced than in most other states because California layers on additional taxes that affect the comparison significantly.
The Basic Federal Tax Argument for S-Corps
At the federal level, the appeal of an S-Corp is clear. A sole proprietor pays self-employment tax (15.3% on the first ~$168,600, then 2.9% on income above that) on all net income. With an S-Corp, you split your income into a "reasonable salary" — subject to payroll taxes — and distributions, which are not subject to self-employment tax. If you're netting $150,000+ per year, the payroll tax savings can be substantial.
A single-member LLC taxed as a sole proprietor has no such split. You pay self-employment tax on everything. That's why many profitable self-employed professionals elect S-Corp status at some income threshold.
California Complicates the Math
Here's where it gets interesting. California imposes its own taxes that reduce or eliminate the S-Corp advantage at lower income levels:
- California S-Corp minimum franchise tax: $800 per year (same as LLC)
- California S-Corp gross receipts tax: An additional tax ranging from $0 to $11,790 depending on California-source gross receipts ($0 under $1M, scaling up from there)
- LLC annual fee: Also based on gross receipts — $0 under $250K, $900 for $250K–$500K, scaling up to $11,790 for income over $5M
The result: at lower California income levels (under $40,000–$50,000 net), the costs of maintaining an S-Corp (payroll service, additional tax returns, state fees) often exceed the payroll tax savings. The S-Corp breakeven in California is generally higher than in states without this extra tax layer.
Practical Thresholds (General Guidance)
These numbers vary based on your specific situation, but as a rough guide:
- Under $50K net profit: LLC (sole proprietor or disregarded entity) is usually simpler and cheaper in California
- $50K–$80K net profit: It depends — run the numbers with a CPA. The crossover point varies by situation.
- $80K+ net profit: S-Corp election often makes sense and typically produces meaningful savings
Other Factors to Consider
Complexity and cost: An S-Corp requires a separate payroll (and payroll tax filings), a corporate tax return (Form 1120-S), and more administrative overhead. That's real cost — typically $1,500–$3,000 more in accounting fees per year than a simple LLC.
Reasonable compensation: The IRS requires that S-Corp owner-employees pay themselves a "reasonable salary" — you can't pay yourself $1 to avoid all payroll taxes. If audited, the IRS can reclassify distributions as wages and assess back payroll taxes plus penalties. Getting the salary right is important.
California LLC fee on gross receipts: If your LLC has high gross receipts but modest net income (common in service businesses with significant pass-through expenses), the LLC fee structure can bite. This is another reason to model it out rather than assume.
The Bottom Line
There is no universal right answer. The best entity structure depends on your net income, gross receipts, growth trajectory, other income sources, and long-term plans. What works at $60K net profit may not be optimal at $200K. And California's unique tax structure means you can't just apply advice from national sources without adjusting for the local context.
Before making a change — or before you file as a new entity for the first time — it's worth sitting down with a CPA who knows California tax law and can model both scenarios for your specific numbers.