# C Corp vs. S Corp for a California Small Business

> C corp or S corp for a California small business? Compare the 8.84% and 1.5% state rates, double tax on dividends, QSBS, and switching, with a worked example.

Source: https://ridleylawoffices.com/c-corp-vs-s-corp-california/

**Short answer:** A C corporation pays its own income tax, and owners pay again on dividends. An S corporation passes income to its owners, who pay once. For a California small business that distributes its profit, the S corporation usually costs less, because California taxes S corporations at 1.5% instead of 8.84%. A C corporation makes more sense for outside investors, foreign owners, or profit kept in the business.

- Federal tax on a C corporation is 21% of taxable income (26 U.S.C. § 11(b)).
- California taxes a C corporation at 8.84% of net income, with an $800 minimum (Rev. & Tax. Code §§ 23151(f)(2) and 23153(d)(1)).
- California taxes an S corporation at 1.5% and keeps it subject to the minimum franchise tax (Rev. & Tax. Code § 23802(b)(1) and (c)), which is $800 (Rev. & Tax. Code § 23153(d)(1)).
- California doesn’t follow the federal small business stock exclusion (Rev. & Tax. Code § 18152).

“C corp” and “S corp” describe how a corporation is taxed, not two different legal entities. Every California corporation starts life taxed as a C corporation. It becomes an S corporation only by filing IRS Form 2553, and California follows that federal election automatically. So the question for a California owner is whether to file that election, and whether a corporation is even the right wrapper. For many small businesses, an [LLC taxed as an S corp](https://ridleylawoffices.com/llc-vs-s-corp-california/) gets the same tax result with less upkeep.

## What’s the difference between a C corp and an S corp?

The difference is who pays the income tax. A C corporation pays tax on its profit, then its shareholders pay tax again on dividends. An S corporation generally pays no federal income tax, and its income, losses, and deductions flow through to the shareholders’ personal returns.

The C corporation’s federal rate is a flat 21% ([26 U.S.C. § 11(b)](https://www.law.cornell.edu/uscode/text/26/11)). When it pays a dividend, the shareholder generally pays federal tax at capital gains rates, 15% for most owners and 20% at the top ([26 U.S.C. § 1(h)(1) and (h)(11)](https://www.law.cornell.edu/uscode/text/26/1)). Higher-income owners can also owe the 3.8% net investment income tax on dividends ([26 U.S.C. § 1411](https://www.law.cornell.edu/uscode/text/26/1411)).

An S corporation shareholder reports a share of the corporation’s income, loss, and deductions on the shareholder’s own return ([26 U.S.C. § 1366(a)](https://www.law.cornell.edu/uscode/text/26/1366)). Losses pass through too, up to the shareholder’s basis in stock and loans to the company (26 U.S.C. § 1366(d)(1)).

## How does California tax C corps and S corps?

California taxes both, at very different rates. A C corporation pays the corporate franchise tax at 8.84% of net income ([Rev. & Tax. Code § 23151(f)(2)](https://leginfo.legislature.ca.gov/faces/codes_displaySection.xhtml?lawCode=RTC&sectionNum=23151)). An S corporation pays 1.5% ([Rev. & Tax. Code § 23802(b)(1)](https://leginfo.legislature.ca.gov/faces/codes_displaySection.xhtml?lawCode=RTC&sectionNum=23802)). Corporations subject to the minimum franchise tax pay $800 a year ([Rev. & Tax. Code § 23153(d)(1)](https://leginfo.legislature.ca.gov/faces/codes_displaySection.xhtml?lawCode=RTC&sectionNum=23153)). An S corporation is subject to it too (Rev. & Tax. Code § 23802(c)).

California doesn’t make you file anything extra to get S treatment. A corporation with a valid federal S election is an S corporation for California purposes ([Rev. & Tax. Code § 23801(a)](https://leginfo.legislature.ca.gov/faces/codes_displaySection.xhtml?lawCode=RTC&sectionNum=23801)). It files Form 100S with the FTB, and a C corporation files Form 100.

| | C corporation | S corporation |
| --- | --- | --- |
| Federal entity tax | 21% | Generally none |
| California entity tax | 8.84%, $800 minimum | 1.5%, $800 minimum |
| Tax on distributions | Dividends taxed to shareholders | Generally not taxed again, up to basis |
| Losses | Stay in the corporation | Pass through to owners, limited by basis |
| Owners | Anyone, any number | Up to 100; U.S. individuals, estates, certain trusts |
| Classes of stock | Any, including preferred | One class (voting differences allowed) |
| Federal small business stock exclusion | Possible under 26 U.S.C. § 1202 | Not available |
| California return | Form 100 | Form 100S |

### First-year break on the minimum tax

A corporation that incorporates or qualifies to do business in California on or after January 1, 2000, isn’t subject to the minimum franchise tax for its first taxable year (Rev. & Tax. Code § 23153(f)(1)). For an S corporation, the FTB says any first-year net income is still taxed at 1.5% ([FTB, S corporations](https://www.ftb.ca.gov/file/business/types/corporations/s-corporations.html)). The exemption doesn’t apply to a corporation that reorganizes solely to avoid the tax (§ 23153(f)(3)).

## Which pays less tax on the same profit?

When the profit gets paid out, the S corporation almost always pays less in California. The side-by-side below uses $100,000 of profit left after the owner’s reasonable salary, all distributed.

Assume Luis owns 100% of an Oxnard manufacturing supply company. He’s already paid himself a reasonable salary, which costs the same payroll tax either way. The company has $100,000 left. Assume Luis is in the 24% federal bracket and the 9.3% California bracket, and ignore the federal qualified business income deduction for now.

| Step | C corporation | S corporation |
| --- | --- | --- |
| California entity tax | $8,840 (8.84%) | $1,500 (1.5%) |
| Federal entity tax | $19,144 (21% of $91,160) | None |
| Cash available to Luis | $72,016 dividend | $98,500 distribution |
| Federal tax to Luis | $10,802 (15% on the dividend) | $23,640 (24% on $98,500) |
| California tax to Luis | $6,697 (9.3% on the dividend) | $9,300 (9.3% on $100,000) |
| **Total tax** | **$45,483** | **$34,440** |

The S corporation saves about $11,000 in this example. The California rate gap is most of the entity-level difference: $8,840 against $1,500. Federal law then taxes the C corporation’s dividend a second time.

If Luis qualifies for the federal 20% deduction for qualified business income under [26 U.S.C. § 199A](https://www.law.cornell.edu/uscode/text/26/199A), the S corporation’s advantage grows. California doesn’t allow that deduction ([FTB, 2025 Schedule K-1 (565) instructions](https://www.ftb.ca.gov/forms/2025/2025-565-k-1-instructions.html)), and C corporations can’t take it at all.

These are simplified numbers. Brackets, the order in which state taxes are deducted, and the net investment income tax all move the result, and your CPA should run the real version.

### When the C corporation comes out ahead

Change the facts so the $100,000 stays in the business to buy equipment and hire. The C corporation pays about $27,984 in entity tax ($8,840 to California and $19,144 federal) and keeps the rest. Luis, as an S corporation owner, would pay tax on income he never received. For a business that reinvests for years, the C corporation can defer tax. The second layer comes later, when profit is paid out as dividends or the owner sells.

## Why would a California business choose a C corp?

A C corporation fits businesses that raise outside capital, have owners the S rules exclude, or keep their earnings working inside the company. Most closely held California businesses don’t fit any of these situations.

- **Investors and preferred stock.** An S corporation can have only one class of stock and no more than 100 shareholders ([26 U.S.C. § 1361(b)(1)](https://www.law.cornell.edu/uscode/text/26/1361)). Venture investors expect preferred stock and often invest through funds or entities that can’t own S stock.
- **Foreign owners.** An S corporation can’t have a nonresident alien shareholder (26 U.S.C. § 1361(b)(1)(C)). In California, a nonresident alien spouse with a community property interest in the shares counts as a shareholder and disqualifies the corporation ([26 C.F.R. § 1.1361-1(g)(1)(i)](https://www.law.cornell.edu/cfr/text/26/1.1361-1)).
- **Federal QSBS.** Stock in a qualifying C corporation can be eligible for the federal gain exclusion under 26 U.S.C. § 1202. California doesn’t follow it ([Rev. & Tax. Code § 18152](https://leginfo.legislature.ca.gov/faces/codes_displaySection.xhtml?lawCode=RTC&sectionNum=18152)), so a California founder still pays state tax on the gain. See [QSBS, Section 1202, and California](https://ridleylawoffices.com/qsbs-section-1202-california/).
- **Owner health benefits.** For an S corporation, health premiums for a more-than-2% shareholder-employee are reported as W-2 wages ([IRS, S corporation compensation and medical insurance issues](https://www.irs.gov/businesses/small-businesses-self-employed/s-corporation-compensation-and-medical-insurance-issues)). That’s a reason some owners compare the two, though the dollar difference is usually small next to the rate gap.

## Can I switch from a C corp to an S corp?

Yes, by filing Form 2553 on time. The catch is the built-in gains tax, which reaches back to value the corporation built up while it was a C corporation. I explain the election itself on [filing Form 2553 and the California S election](https://ridleylawoffices.com/s-corp-election-form-2553-california/).

- **Built-in gains, federal.** If a former C corporation sells assets that had appreciated before the S election, it pays corporate tax at the highest § 11(b) rate on that gain during the recognition period ([26 U.S.C. § 1374(b)(1)](https://www.law.cornell.edu/uscode/text/26/1374)). The federal recognition period is 5 years from the first S year (26 U.S.C. § 1374(d)(7)(A)).
- **Built-in gains, California.** California imposes its own built-in gains tax, at the rate imposed under Rev. & Tax. Code § 23151 ([Rev. & Tax. Code § 23809(a)(1)](https://leginfo.legislature.ca.gov/faces/codes_displaySection.xhtml?lawCode=RTC&sectionNum=23809)). That rate is 8.84% (Rev. & Tax. Code § 23151(f)(2)). California substitutes a 10-year recognition period for the federal 5-year period (§ 23809(e)), and the FTB’s [S Corporation Manual](https://www.ftb.ca.gov/tax-pros/procedures/s-corp-handbook/s-corp-chapter-5.pdf) says the 10-year period “remains in effect for California purposes for all tax years”. An asset sold in years 6 through 10 can owe California built-in gains tax with no federal tax, so plan the timing with your CPA.
- **Leftover C corporation earnings.** A former C corporation with accumulated earnings can lose its S status if passive investment income, such as rents, interest, and dividends, exceeds 25% of gross receipts for three years in a row ([26 U.S.C. § 1362(d)(3)](https://www.law.cornell.edu/uscode/text/26/1362)). California also taxes excess passive income at the corporate rate ([Rev. & Tax. Code § 23811(b)(1)](https://leginfo.legislature.ca.gov/faces/codes_displaySection.xhtml?lawCode=RTC&sectionNum=23811)).

## Can I switch from an S corp back to a C corp?

Yes. Shareholders can revoke the election, and some events terminate it automatically. A federal termination also ends the California S status at the same time, unless it was an inadvertent termination the IRS relieves (Rev. & Tax. Code § 23801(e)(1)).

Think hard before revoking. Once the election ends, the corporation generally needs IRS consent to re-elect S status before the fifth tax year after the termination took effect ([IRS, Instructions for Form 2553](https://www.irs.gov/instructions/i2553)). Owners sometimes revoke to take on venture investors, which is a sound reason. Revoking to save a little tax in one year rarely is.

## What stays the same for both?

The legal side is identical. A C corporation and an S corporation are the same kind of California corporation, with the same liability protection, the same board and officers, and the same filings.

- **Annual Statement of Information.** Every corporation files one within 90 days after formation and every year after ([Corp. Code § 1502(a)](https://leginfo.legislature.ca.gov/faces/codes_displaySection.xhtml?lawCode=CORP&sectionNum=1502)). See [the California Statement of Information](https://ridleylawoffices.com/statement-of-information-california/).
- **Owner payroll.** Any corporate officer is an employee for California unemployment insurance purposes ([Unemp. Ins. Code § 621(a)](https://leginfo.legislature.ca.gov/faces/codes_displaySection.xhtml?lawCode=UIC&sectionNum=621)). A working owner of either kind of corporation goes on payroll.
- **Keeping the shield.** Commingled funds and thin records can let a creditor reach the owners either way. See [piercing the corporate veil in California](https://ridleylawoffices.com/piercing-corporate-veil-california/).
- **Licensed professions.** Doctors, lawyers, CPAs, and other licensees practice through a [professional corporation](https://ridleylawoffices.com/professional-corporation-california/), which can be taxed as a C or S corporation.

If the corporation has more than one owner, a [buy-sell agreement](https://ridleylawoffices.com/buy-sell-agreement-california/) should address the S election directly. A transfer to an ineligible owner, such as a nonresident alien or a non-qualifying trust, ends it for everyone.

## Frequently asked questions

### Is it better to be an S corp or a C corp in California?

For most owner-operated California businesses that pay out their profit, the S corporation costs less. California’s 1.5% S rate against its 8.84% corporate rate explains much of that, and federal law adds a second tax on C corporation dividends. The C corporation fits venture-backed companies, foreign owners, and businesses that reinvest nearly everything.

### What is the C corporation tax rate in California?

California taxes a C corporation at 8.84% of net income, with an $800 minimum (Rev. & Tax. Code §§ 23151(f)(2) and 23153(d)(1)). The federal rate is 21% on top of that. Banks and financial corporations are excluded from that section and taxed under separate rules.

### Do C corps pay more tax than S corps?

On distributed profit, usually yes, because the income is taxed at the corporate level and again as dividends. In my $100,000 example the C corporation’s owners pay about $11,000 more. On profit kept in the business, the C corporation can pay less in the short run.

### Can one person own a C corp or an S corp?

Yes. A single shareholder can own either. A one-owner corporation still needs a board (which can be the owner), officers, the annual Statement of Information, and payroll if the owner works in the business.

### Can an LLC be taxed as a C corp?

Yes. An LLC can elect to be taxed as a corporation, and it stays an LLC under California law. California follows the federal classification, so it’s then a corporation for the franchise tax ([Rev. & Tax. Code § 23038(b)(2)(B)(ii) and (c)](https://leginfo.legislature.ca.gov/faces/codes_displaySection.xhtml?lawCode=RTC&sectionNum=23038)). It rarely makes sense for a small business, and it doesn’t qualify for the federal exclusion in 26 U.S.C. § 1202, which requires a C corporation.

### Does California recognize the S election?

Yes, automatically. A corporation with a valid federal S election is an S corporation for California (Rev. & Tax. Code § 23801(a)). It files Form 100S and pays the 1.5% tax.

More in this series

- [LLC vs. S corp in California](https://ridleylawoffices.com/llc-vs-s-corp-california/)
- [Filing Form 2553 and the California S election](https://ridleylawoffices.com/s-corp-election-form-2553-california/)
- [S corp reasonable salary for California owners](https://ridleylawoffices.com/s-corp-reasonable-salary-california/)
- [Single-member LLC or S corp election](https://ridleylawoffices.com/single-member-llc-vs-s-corp-california/)
- [California professional corporations](https://ridleylawoffices.com/professional-corporation-california/)
- [Entity formation](https://ridleylawoffices.com/entity-formation/)
- [All business owner guides](https://ridleylawoffices.com/business-guides/)

My [entity formation](https://ridleylawoffices.com/entity-formation/) service is a flat fee, including $4,500 for a professional corporation. Converting or restructuring an existing corporation is billed at $500 per hour; see [fees](https://ridleylawoffices.com/fees/).

[Talk to Eric](https://ridley.click/eric-60)

Book a consultation at [ridley.click/eric-60](https://ridley.click/eric-60) or call 805-244-5291. I work with business owners in Ventura, Santa Barbara, and Los Angeles counties by Zoom or phone.

**Please read:** This page is general information about California law as of September 2026. It isn’t legal, tax, or financial advice, and reading it doesn’t make you my client. Tax treatment and the right structure depend on facts this page can’t see, so talk with your CPA as well. An attorney-client relationship starts only with a signed engagement agreement.