The main difference between an S corp, an LLC and a C corp is how they are taxed and who can own them. An LLC is a flexible entity that is taxed as a pass-through by default. A C corporation pays its own income tax and its shareholders are taxed again on dividends, but it can have any number and type of owners. An S corporation is not a separate entity at all; it is a federal tax election that lets an eligible corporation or LLC pass income through to its owners, subject to strict ownership limits.
Choosing a structure affects taxes, fundraising, equity compensation and even how easily the business can be sold. Founders often pick an entity based on what a friend used, then discover later that it does not fit their plans. Here is how the three options compare, with a focus on structure and taxes in California.
The Limited Liability Company (LLC)
Structure
An LLC is owned by members and can be managed by its members or by appointed managers. Its operating agreement can customize governance, economics and transfer rules with considerable freedom. There are no limits on the number or type of members: individuals, corporations, funds and foreign persons can all own LLC interests. Members generally are not personally liable for the LLC’s debts.
Taxes
By default, a single-member LLC is disregarded for federal income tax purposes, and a multi-member LLC is taxed as a partnership. Profits and losses pass through to the members, who report them on their own returns. Active members may owe self-employment tax on their share of the business’s earnings. An LLC can instead elect to be taxed as a corporation, and then, if eligible, elect S corporation status.
In California, LLCs pay an $800 minimum annual tax and, once total California gross receipts exceed a threshold, an additional fee that increases with gross receipts.
The S Corporation
Structure and eligibility
To elect S status by filing IRS Form 2553, the entity must meet requirements that include:
- No more than 100 shareholders (with family members able to be treated as one shareholder).
- Shareholders generally must be U.S. citizens or resident individuals, certain trusts and estates, or certain tax-exempt organizations. Corporations, partnerships, most LLCs with multiple members, and nonresident aliens cannot be shareholders.
- Only one class of stock. Differences in voting rights are allowed, but all shares must have identical rights to distributions and liquidation proceeds.
Because venture funds typically invest through partnerships or LLCs, and because investors usually want preferred stock, an S corporation is generally not compatible with venture capital financing. A corporation that later raises venture money usually revokes or loses its S election.
Taxes
An S corporation’s income, losses and deductions pass through to shareholders in proportion to their ownership, and the entity generally pays no federal income tax. Shareholders who work in the business must be paid reasonable compensation as W-2 employees, subject to payroll taxes. Remaining profits distributed to shareholders are not subject to Social Security and Medicare taxes, which is the main reason many owner-operated businesses choose S status. The IRS scrutinizes salaries that are unreasonably low compared with distributions.
California does not fully follow the federal pass-through approach: S corporations pay a 1.5 percent franchise tax on net income, subject to the $800 minimum. See our post on understanding S corporations.
The C Corporation
Structure
A C corporation is a separate legal entity owned by shareholders, who elect a board of directors, which appoints officers to run day-to-day operations. It can have unlimited shareholders of any type and multiple classes of stock, including the preferred stock that venture investors expect. It is the standard structure for companies planning to raise institutional capital, grant stock options broadly or go public.
Taxes
C corporations pay federal income tax at a flat 21 percent rate and California franchise tax at 8.84 percent of net income allocated to California, with an $800 minimum. When profits are distributed as dividends, shareholders pay tax again, which is the “double taxation” associated with C corporations. In practice, many growth companies reinvest earnings rather than paying dividends, so the second layer of tax may matter less than it first appears.
C corporation stock may also qualify for the qualified small business stock (QSBS) exclusion under Internal Revenue Code section 1202, which can exclude some or all of the gain on a sale of qualifying stock from federal tax. Federal legislation in 2025 expanded this benefit for stock issued after its enactment. California does not conform to the federal QSBS exclusion. See our post on the qualified small business stock exclusion.
Side-by-Side Summary
- Ownership limits: LLC, none; S corp, 100 eligible shareholders and one class of stock; C corp, none.
- Federal income tax: LLC, pass-through by default; S corp, pass-through; C corp, entity-level tax plus tax on dividends.
- California entity-level tax: LLC, $800 plus gross receipts fee; S corp, 1.5 percent of net income with $800 minimum; C corp, 8.84 percent with $800 minimum.
- Payroll tax savings for owner-employees: Most available with an S corp.
- Venture capital and stock options: Generally require a C corp.
How to Decide
A service business or small company owned by a few U.S. individuals and planning to distribute profits may benefit from an LLC or an S corporation. A startup planning to raise venture capital, grant options to employees or pursue QSBS benefits usually forms a C corporation from the start, often in Delaware. Converting later is possible but can trigger tax costs and paperwork. Our business formation page outlines the process.
The Takeaway
LLCs offer flexibility and pass-through taxation, S corporations offer payroll tax savings for eligible owners, and C corporations offer the structure investors expect. The right choice depends on who will own the business, how you plan to fund it and how you expect to exit. Because tax rules change, consult both legal and tax advisors before deciding.
Frequently Asked Questions
Is an S corp a type of business entity?
No. An S corporation is a federal tax election, not a separate type of entity. A corporation, or an LLC that elects to be taxed as a corporation, can elect S status by filing IRS Form 2553 if it meets the eligibility requirements.
Can an LLC have foreign owners and still be taxed as a pass-through?
Yes. Unlike an S corporation, an LLC taxed as a partnership can have foreign members, other companies and investment funds as owners. Foreign members can create additional withholding and filing obligations, but they do not by themselves cause the LLC to lose pass-through treatment.
Which structure do venture capital investors prefer?
Venture capital investors generally prefer to invest in C corporations, most often Delaware corporations. C corporations can issue preferred stock, have unlimited and varied shareholders, support standard stock option plans and may allow shareholders to qualify for the qualified small business stock exclusion.
What is the minimum California tax for an LLC, S corp or C corp?
California generally imposes an $800 minimum annual franchise tax on LLCs, S corporations and C corporations doing business in or organized in the state. LLCs may also owe a separate fee based on gross receipts, S corporations pay a reduced corporate franchise tax rate on net income, and C corporations pay the full corporate rate.
How Sutter Law Can Help
We help founders choose and form the right entity, prepare governing documents and plan for financings and equity compensation, working alongside your tax advisor. Learn more about our startup law practice, or contact us for a free consultation.
This article is general information, not legal advice. Reading it does not create an attorney-client relationship.
