Choosing the right business structure is one of the most important financial decisions a California contractor makes. The two most popular options — LLC (Limited Liability Company) and S-Corp (S Corporation) — each come with distinct tax advantages and drawbacks. Pick the wrong one and you could be paying thousands of dollars more in taxes every year.
This guide breaks down the real-world tax differences between LLCs and S-Corps specifically for California contractors, including the profit threshold where switching structures starts to make sense.
Default LLC Tax Treatment: The Self-Employment Tax Problem
When you form an LLC and do not make any special tax elections, the IRS treats it as a “disregarded entity” (for single-member LLCs) or a partnership (for multi-member LLCs). All of the business profit flows through to your personal tax return.
Here is the problem: all of that profit is subject to self-employment (SE) tax, which covers Social Security and Medicare. The total SE tax rate is 15.3% on the first $168,600 of net earnings (2026 threshold), broken down as:
- 12.4% for Social Security
- 2.9% for Medicare (no income cap)
This means if your LLC earns $100,000 in profit, you owe approximately $15,300 in self-employment tax alone — before income tax. For many contractors, SE tax is their single largest tax burden.
How the S-Corp Strategy Works
An S-Corp is not actually a different type of business entity — it is a tax election. You can form an LLC and then elect S-Corp tax treatment with the IRS by filing Form 2553. You get the liability protection of an LLC with the tax treatment of an S-Corp.
The Salary-Splitting Strategy
Here is why contractors love the S-Corp election: as an S-Corp, you split your business income into two buckets:
- Reasonable salary: You pay yourself a W-2 salary that is subject to payroll taxes (the S-Corp equivalent of SE tax)
- Distributions: The remaining profit is taken as shareholder distributions, which are not subject to self-employment or payroll tax
Only the salary portion gets hit with the 15.3% payroll tax. The distribution portion avoids it entirely.
Example: $120,000 in Business Profit
| Scenario | LLC (Default) | S-Corp Election |
|---|---|---|
| Business profit | $120,000 | $120,000 |
| Reasonable salary | N/A | $60,000 |
| Distribution | N/A | $60,000 |
| SE/payroll tax base | $120,000 | $60,000 |
| SE/payroll tax (15.3%) | $18,360 | $9,180 |
| Tax savings | — | $9,180 |
In this example, the S-Corp election saves the contractor over $9,000 per year in self-employment tax. The income tax on the total $120,000 is the same either way — the savings come entirely from reducing the payroll tax base.
The Profit Threshold: When Does an S-Corp Make Sense?
The S-Corp election is not free. It comes with additional costs and complexity:
- Payroll processing: You must run formal payroll for yourself, which typically costs $500-$2,000/year through a payroll service
- Additional tax filings: S-Corps file a separate corporate tax return (Form 1120-S), which costs $500-$1,500 in CPA fees
- Reasonable salary requirement: The IRS requires your salary to be “reasonable” for the work you do — setting it too low is a major audit red flag
When you add up these costs, the S-Corp election generally starts saving money when your business nets $50,000 to $60,000 or more in annual profit. Below that threshold, the added costs of payroll and tax preparation eat into or exceed the tax savings.
Quick Breakeven Analysis
| Annual Profit | SE Tax Savings | S-Corp Added Costs | Net Benefit |
|---|---|---|---|
| $30,000 | ~$2,300 | ~$2,000-$3,000 | Break even or loss |
| $50,000 | ~$3,800 | ~$2,000-$3,000 | $800-$1,800 savings |
| $75,000 | ~$5,700 | ~$2,000-$3,000 | $2,700-$3,700 savings |
| $100,000 | ~$7,650 | ~$2,000-$3,000 | $4,650-$5,650 savings |
| $150,000 | ~$11,500 | ~$2,000-$3,000 | $8,500-$9,500 savings |
As you can see, the higher your profit, the more the S-Corp election saves you.
California-Specific Considerations
The $800 Franchise Tax
California charges an $800 annual franchise tax to both LLCs and S-Corps. This is a flat fee due every year regardless of how much your business earns. There is no avoiding it with either structure (new businesses may qualify for a first-year exemption).
LLC Gross Receipts Fee
California LLCs (not S-Corps) are also subject to an additional fee based on gross receipts:
- $250,000 – $499,999 gross receipts: $900 fee
- $500,000 – $999,999 gross receipts: $2,500 fee
- $1,000,000 – $4,999,999 gross receipts: $6,000 fee
- $5,000,000+ gross receipts: $11,790 fee
Note: this is based on gross receipts (revenue), not profit. For contractors who do high-volume work with thin margins, this fee can be significant. Electing S-Corp treatment eliminates this LLC fee.
CSLB Bond Requirement for LLCs
This is a big one that many tax advisors overlook. If you operate as an LLC, the CSLB requires an additional $100,000 surety bond on top of the standard $25,000 contractor bond. This LLC bond typically costs $1,000 to $5,000+ per year depending on your credit.
Corporations (including S-Corps that are formed as corporations) do not have this additional bond requirement. This extra bonding cost is a major factor in the LLC vs. S-Corp decision for California contractors specifically.
Pros and Cons Summary
LLC (Default Tax Treatment)
Pros:
- Simplest to set up and maintain
- No payroll requirements
- Lower annual accounting costs
- Flexible profit distribution among members
Cons:
- 15.3% SE tax on all profit
- California gross receipts fee on revenue over $250K
- Additional $100,000 CSLB bond requirement (extra $1,000-$5,000+/year)
S-Corp (Tax Election)
Pros:
- Significant SE tax savings above $50-60K profit
- No California gross receipts fee
- No additional CSLB bond requirement (if formed as a corporation)
- More professional business structure for larger clients
Cons:
- Must run payroll and pay payroll taxes
- Higher accounting and tax preparation costs
- Reasonable salary requirement from the IRS
- Less flexibility in profit distribution
- More administrative complexity
Which One Should You Choose?
Here is a simple decision framework:
- Profit under $40K/year: Stay with a default LLC or sole proprietorship. The S-Corp costs will likely exceed the savings.
- Profit $50K-$75K/year: The S-Corp election starts making sense. Run the numbers with a CPA who understands contractor businesses.
- Profit over $75K/year: An S-Corp almost certainly saves you money. The savings become substantial and grow with your income.
- Revenue over $250K (even with thin margins): Consider the S-Corp election to avoid the California LLC gross receipts fee.
How to Make the Switch
If you currently have an LLC and want S-Corp treatment:
- File IRS Form 2553 (Election by a Small Business Corporation) — must be filed by March 15 for the current tax year, or within 75 days of forming your LLC
- Set up a payroll system and begin paying yourself a reasonable salary
- Update your accounting to track salary vs. distributions
- Hire a CPA or tax professional experienced with S-Corps
Alternatively, you can form a new corporation with the California Secretary of State and register it with the CSLB. This avoids the LLC’s additional $100,000 bond requirement entirely.
Get Your Structure Right from the Start
Your business structure affects your taxes, your bonding costs, and your long-term profitability. Making the right choice now can save you tens of thousands of dollars over the life of your contracting business.
For help navigating the full licensing and business setup process, visit our License Setup guide. And remember — always consult with a CPA or tax professional who understands California contractor businesses before making structural changes.