LLC vs. S-Corp in California: where the break-even point really is

The two are not alternatives

People ask "LLC or S-Corp?" as if they were competing. They are not. An LLC is what you form with the Secretary of State. An S-Corporation is how you ask the IRS to tax it. A California LLC can stay taxed as a sole proprietorship or partnership, or it can file Form 2553 and be taxed as an S-Corp. The question is only ever about the election.

What the election changes

Without it, all net profit of an owner-operated LLC is subject to self-employment tax at 15.3% (up to the Social Security wage base, then 2.9%). With it, you pay yourself a salary through payroll, which carries payroll tax, and take the rest as distributions, which do not. The saving is the payroll tax on the distribution portion.

What the election costs

Payroll must run (software plus filings), a separate business return (1120-S) must be filed, and California charges S-Corporations a 1.5% franchise tax on net income with an $800 minimum — versus the LLC's $800 plus a gross-receipts fee. Add roughly $2,000–3,500 a year in real costs for a small firm.

The break-even

Take your expected net profit, subtract a reasonable salary for the work you do, and multiply the remainder by 15.3% (or 2.9% above the wage base). If that number is comfortably above the added costs, the election pays. For most owner-operators in California that happens between $50,000 and $70,000 of net profit. Below that, stay simple.

Reasonable salary is not optional

The IRS expects an S-Corp owner-employee to be paid what the job would pay someone else. Setting a $20,000 salary on $200,000 of profit invites reclassification of distributions as wages, with back payroll taxes and penalties. We document the salary with market data each year.

Timing

Form 2553 is due within two months and fifteen days of the start of the tax year you want it to apply to, or any time in the prior year. Late elections are often accepted with a reasonable-cause statement, but do not count on it. If you are close to the break-even, decide in the fourth quarter.

This article is general information, not advice for your situation. Facts and thresholds change; confirm before acting.