The Hedge | Brutal Honesty Over Hype Since 2008
The LLC vs. S-corporation question is one of the most frequently asked and most frequently over-simplified questions in small business formation. The honest answer depends on specific revenue levels, owner compensation structures, and state tax exposure — and the California-specific analysis produces different conclusions than the federal analysis alone. Here is the framework for making the right choice.
The Self-Employment Tax Arbitrage
The primary financial reason to elect S-corporation status over single-member LLC taxation is self-employment tax savings. LLC members who are active in their business pay self-employment tax (15.3% on the first $168,600, 2.9% above that) on their entire net business income. S-corporation shareholders pay self-employment taxes only on their W-2 wages — not on distributions. An active business owner with $200,000 in net income can save approximately $10,000-$15,000 annually in self-employment taxes by electing S-corporation status and paying themselves a reasonable but below-profit salary.
The California Complication
California’s S-corporation tax structure adds a layer that the federal analysis doesn’t account for. California imposes a 1.5% franchise tax on S-corporation net income (minimum $800) in addition to the federal S-corporation treatment. California does not conform to the federal S-corporation election in every respect. For California-specific analysis, the S-corp advantage must be calculated net of this additional California franchise tax burden. At lower income levels — below approximately $80,000 in net income — the administrative cost of maintaining S-corporation status (payroll, separate tax filings) often exceeds the self-employment tax savings, even without the California complication.
The Crossover Point
For most California small businesses, the LLC-to-S-corp election makes economic sense at approximately $80,000-$100,000 in annual net business income after deducting a reasonable owner salary. Below that threshold, the administrative costs and California S-corp franchise tax generally outweigh the self-employment tax savings. Above that threshold, the analysis typically favors S-corp election, with the savings growing proportionally as income increases. Calculate your specific crossover point with a CPA who understands both federal and California tax structures before making the election.
The Hedge has been cutting through financial and business noise since 2008. Brutal honesty over hype — always.
