What are the tax implications of different business structures in 2024-2025?
- Rebecca Tabert, CPA
- Jul 22
- 12 min read
Choosing the right business structure can have a major impact on your tax bill, liability, and reporting requirements. Whether you are starting a new business or reassessing your current setup, it is important to understand how sole proprietorships, partnerships, LLCs, S Corporations, and C Corporations are taxed in 2025–2026 and what that means for your bottom line.
Many business owners do not realize how much their choice of business structure can influence their taxes, personal liability, and the paperwork they must file. Each type of business, whether it is a sole proprietorship, partnership, LLC, S Corporation, or C Corporation, comes with its own tax rules, filing deadlines, and levels of separation between the business and the owner. Some structures pass income directly to the owner’s personal tax return, while others file separate business tax returns and pay corporate income tax.
Understanding how your business is taxed can help you avoid surprises at tax time, take advantage of available deductions, and choose a structure that fits your goals.
What are the types of business structures I can be and their tax implications?
Choosing a business structure affects everything from how you pay taxes to how much personal liability you have. Each structure has specific tax treatment at both the federal and California levels.
1. Sole Proprietorship
Federal Taxes:
Income is reported on the owner’s Form 1040, Schedule C.
Profits are subject to self-employment tax (Social Security and Medicare).
No separate business return is filed.
California Taxes:
Reports income on Form 540 (personal CA return).
No separate franchise tax is due.
May owe city business license taxes depending on location.
Example: A freelance graphic designer using their own name and social security number.
2. Partnership (General or Limited)
Federal Taxes:
Files an informational tax return (Form 1065).
Each partner receives a Schedule K-1, reporting their share of profit/loss.
Income passes through to personal tax returns.
California Taxes:
Must file Form 565.
Subject to a $800 minimum annual tax (exceptions for first year may apply).
California also taxes partners on their distributive share.
Example: Two friends opening a small bakery without forming an LLC or corporation.
3. Limited Liability Company (LLC)
Federal Taxes:
By default, single-member LLCs are taxed as sole proprietors (Schedule C), and multi-member LLCs as partnerships (Form 1065).
Can elect to be taxed as a C Corporation (Form 1120) or S Corporation (Form 1120-S).
California Taxes:
Pays the $800 annual franchise tax (first-year exemption applies for newly formed LLCs).
Also subject to an LLC fee based on gross receipts (Form 568).
Must file Form 568, even if electing S or C Corp tax treatment.
Example: A real estate investor with rental properties held under an LLC taxed as a sole proprietorship.
4. S Corporation
Federal Taxes:
Files Form 1120-S.
No corporate income tax; profits/losses passed through to shareholders via Schedule K-1.
Shareholder-employees must pay themselves “reasonable compensation” subject to payroll taxes.
California Taxes:
Must file Form 100S.
Pays 1.5% franchise tax on net income (or $800 minimum).
Shareholders also pay personal income tax on their share of profits.
Example: A consulting business that elects S Corp status to reduce self-employment tax burden while drawing a salary.
5. C Corporation
Federal Taxes:
Files Form 1120 and pays corporate income tax on profits (currently 21% flat rate).
Dividends paid to shareholders are taxed again on their personal returns (double taxation).
California Taxes:
Files Form 100.
Pays 8.84% corporate income tax, or a minimum of $800.
Shareholders pay tax on dividends if issued.
Example: A technology startup seeking investors and long-term growth, planning to reinvest profits instead of distributing them.
Summary:
Structure | Federal Filing | CA Filing | Self-Employment Tax | Pass-through Income | CA Minimum Tax |
Sole Prop | 1040 + Schedule C | 540 | Yes | Yes | No |
Partnership | 1065 + K-1s | 565 + K-1s | Yes | Yes | $800 |
LLC (Default) | Schedule C or 1065 | 568 | Yes (unless Corp) | Yes (unless Corp) | $800 + fee |
S Corporation | 1120-S + K-1s | 100S + K-1s | Salary only | Yes | $800 or 1.5% |
C Corporation | 1120 | 100 | No | No | $800 or 8.84% |
The best structure for you may change as your business grows or your financial goals shift. It is wise to revisit this decision annually and consult a tax advisor to make sure your current structure still aligns with your needs.
How do I choose the best business structure?
Choosing the right business structure depends on several factors, including how you want to be taxed, the level of personal liability you are willing to assume, your plans for growth, and your ability to handle administrative requirements. There is no one-size-fits-all answer—your choice should reflect your business goals, income expectations, risk tolerance, and compliance capacity.
1. Tax Treatment Preferences
Do you want business income to flow through to your personal return (pass-through taxation)?
Are you planning to reinvest most profits in the business and avoid personal taxation on distributions?
Examples:
A sole proprietor with modest profits may prefer a sole proprietorship for simplicity.
A high-income consultant might benefit from S Corporation status to reduce self-employment tax.
A startup seeking venture capital and reinvestment potential may choose a C Corporation.
2. Liability Protection Needs
Do you want to limit your personal exposure to lawsuits, debts, or other legal issues?
If so, consider an LLC, S Corporation, or C Corporation, all of which provide limited liability.
Note: In California, even single-member LLCs provide legal separation from personal assets—if properly maintained.
3. Administrative Complexity and Cost
How much paperwork and compliance can you realistically handle?
Simpler structures like sole proprietorships and partnerships have fewer filing requirements.
Corporations and LLCs require regular filings, separate bank accounts, formal meeting records, and possibly payroll systems.
California-specific examples:
LLCs and corporations must register with the California Secretary of State, pay the $800 annual franchise tax, and maintain good standing to avoid penalties.
4. Future Business Plans
Do you plan to add partners, raise capital, or sell the business?
Corporations, especially C Corporations, are better suited for investors.
Partnerships and LLCs offer flexibility in ownership structure and profit-sharing arrangements.
Example:
A family-run construction business may prefer an LLC for pass-through taxation and ease of management.
A tech startup looking to raise Series A funding would likely incorporate as a Delaware C Corporation, but still need to register as a foreign corporation in California.
5. State and Local Considerations
California imposes different taxes and compliance requirements on different structures.
You may also be subject to gross receipts fees (for LLCs), estimated taxes (for corporations), or business license taxes (based on your city).
Examples:
A small ecommerce LLC in Los Angeles may owe city tax and a gross receipts fee on top of the state $800 franchise tax.
A corporation earning $500,000 may owe 8.84% corporate income tax plus estimated payments throughout the year.
Summary of Questions to Ask Yourself:
Do I want pass-through taxation or separate business taxation?
Do I need personal liability protection?
How complex of a structure am I willing to manage?
Am I looking for funding or planning to stay small?
What are the state and local costs and rules?
When should I choose my business structure?
You should choose your business structure before you begin operating, especially if you want to take full advantage of tax planning, legal protection, and regulatory compliance from the start. However, if your business has already started informally—such as a sole proprietorship or informal partnership—you may still be able to switch structures later, though certain elections have time limits and may carry tax consequences.
1. Before You Begin Earning Income
Ideally, select a structure before you start doing business (i.e., signing contracts, making sales, or hiring).
Registering with the state and obtaining an EIN is often required for formal structures like LLCs and corporations.
Example:
A new catering business chooses to form an LLC before booking events so they can separate liability and open a dedicated business bank account.
2. Before the Tax Year Begins or Early in the Year
Certain elections, like electing S Corporation tax treatment, must be made by March 15 (or within 75 days of forming the business).
Changing to a C Corporation or switching from a disregarded entity to a partnership may have specific federal and California deadlines.
Example:
An LLC wants to elect S Corporation status for 2026. It must file Form 2553 with the IRS no later than March 15, 2026.
3. After a Change in Business Activity or Income
If your business income has significantly increased or you are taking on new partners or investors, you may need to switch from a sole proprietorship or partnership to a more formal structure.
Example:
A freelance designer earning $40,000 per year may operate as a sole proprietor, but if they expand and earn $200,000, electing S Corporation status may reduce self-employment taxes.
4. After Moving to or Operating in California
California has its own registration requirements, especially for LLCs, corporations, and out-of-state entities doing business in California.
Businesses must register with the California Secretary of State, pay applicable fees, and file annual returns even if already formed in another state.
Timeline for Choosing and Formalizing Your Structure:
Before Operations Begin:
Choose structure
Register entity (LLC/Corp) with CA Secretary of State
Obtain EIN from IRS
Open business bank accounts
Within 75 Days of Formation or Jan 1–Mar 15 (for S Corps):
File Form 2553 for S Corporation election
Ongoing / Annually:
Reassess structure based on income, liability, or growth changes
Renew registrations and file annual reports with California
Choosing your structure at the right time can help you reduce tax liability, protect personal assets, and avoid costly penalties or restructuring fees. If you are unsure, it is best to speak with a tax professional early in your business planning process.
What steps to starting my business structure?
Starting a business structure involves more than just deciding on a name—it requires careful planning, formal registration, and compliance with both federal and state-level requirements. Below are the general steps you should follow to form and formalize your chosen business structure in 2025–2026, with specific notes for California:
1. Choose the Right Business Structure
Consider liability protection, tax implications, ownership needs, and administrative complexity.
Common structures include sole proprietorship, partnership, LLC, S Corporation, and C Corporation.
2. Choose a Business Name
Check for availability through the California Secretary of State and the U.S. Patent and Trademark Office (USPTO).
For sole proprietorships or partnerships, you may need to file a Fictitious Business Name (FBN) with the county.
3. Register with the IRS and Obtain an EIN
Apply for a Federal Employer Identification Number (EIN) through the IRS (required for most structures except some sole proprietorships).
The EIN is used for taxes, hiring employees, and opening business bank accounts.
4. Register Your Entity with California (If Applicable)
LLCs and Corporations must file with the California Secretary of State.
LLCs: File Articles of Organization (Form LLC-1)
Corporations: File Articles of Incorporation (Form ARTS-GS or ARTS-STOCK)
File the Initial Statement of Information (Form LLC-12 or SI-550) within 90 days of formation.
5. Make Any Federal Tax Elections (If Needed)
If electing S Corporation status, file Form 2553 with the IRS within 75 days of formation or by March 15 of the tax year.
LLCs may also file Form 8832 to elect corporate tax treatment.
6. Open a Business Bank Account and Set Up Accounting
Use your EIN and registration documents to open dedicated business accounts.
Set up bookkeeping software or work with an accountant to track income, expenses, payroll, and taxes.
7. Obtain Business Licenses and Permits
Register for a local business license with your city or county.
Check for any industry-specific licenses or permits (health permits, seller’s permit, etc.).
8. File for California Taxes
Register with the California Department of Tax and Fee Administration (CDTFA) for sales tax, use tax, and other state taxes if applicable.
Corporations and LLCs must pay the $800 annual minimum franchise tax, and LLCs may owe a gross receipts fee.
9. Maintain Annual Compliance
File annual tax returns with the IRS and California Franchise Tax Board (FTB).
Submit the Statement of Information biennially (or annually for some corps).
Keep up-to-date meeting minutes, payroll filings, and business records.
Quick Reference Checklist:
Choose structure and name
Obtain EIN
Register with CA Secretary of State
File Statement of Information
Make tax elections (if needed)
Open bank accounts
Set up accounting
Apply for business licenses
Register with CDTFA (if applicable)
File tax returns and maintain compliance
Most common myths about business structures
Myth: Forming an LLC automatically saves me money on taxes.
Reality: While LLCs offer liability protection and flexibility, they do not automatically result in tax savings. In fact, single-member LLCs are taxed the same as sole proprietors by default, and multi-member LLCs are taxed as partnerships unless an election is made. Any tax benefit depends on how the LLC is taxed, your income level, and your business goals.
Myth: S Corporations are always better than LLCs.
Reality: S Corporations can reduce self-employment taxes through salary and distribution splits, but they require strict compliance, including payroll setup, officer compensation, and more complex reporting. For smaller businesses or those with variable income, an LLC may be more flexible and less burdensome. In California, both still owe the $800 minimum tax, and LLCs may face additional fees based on gross receipts.
Myth: I do not need to register my business with California if I already formed it in another state.
Reality: If you are conducting business in California - even remotely - you must register as a foreign entity with the California Secretary of State. You will still owe the $800 franchise tax and must file state tax returns. Operating without registration can result in penalties and the inability to enforce contracts.
Myth: Sole proprietors do not have to pay taxes until they make a profit.
Reality: Even if your business operates at a loss, you are still required to report all income and expenses on your personal tax return. You may not owe tax if your net income is negative, but you must still file. In some cases, losses can offset other income, which may reduce your overall tax bill.
Myth: I can change my business structure at any time with no consequences.
Reality: While it is possible to change structures, doing so may create tax consequences, especially if assets, liabilities, or ownership changes are involved. Electing S Corporation status or converting to a C Corporation has strict deadlines and procedural requirements. Late or incorrect filings can result in missed tax benefits or penalties.
(FAQ) Frequently asked questions about business structures
Question: Can I form an LLC and still be taxed as an S Corporation?
Answer: Yes, a Limited Liability Company can elect to be taxed as an S Corporation by filing IRS Form 2553. This allows you to maintain the legal flexibility of an LLC while potentially reducing self-employment taxes through salary and dividend distributions. However, this election requires careful planning, payroll setup, and compliance with both IRS and California rules.
Question: What is the $800 California franchise tax, and does everyone pay it?
Answer: Most California LLCs, S Corporations, and C Corporations must pay a minimum franchise tax of $800 each year, regardless of income. There is a first-year exemption for newly formed or qualified LLCs and corporations, but it does not apply to all entities. Partnerships and sole proprietors are generally not subject to this fee.
Question: What happens if I start as a sole proprietorship but want to change to an LLC later?
Answer: You can switch from a sole proprietorship to an LLC at any time by filing the proper formation documents with the California Secretary of State and applying for a new EIN (in most cases). However, you should also update contracts, licenses, and tax registrations to reflect the new entity. This change may also impact how your income is reported on your tax return.
Question: Do I need a business license if I already registered my LLC or corporation?
Answer: Yes, registering your entity with the state is separate from obtaining local business licenses. Most California cities and counties require a business license or tax registration, even for home-based or online businesses. Failing to obtain the correct licenses can result in fines or back taxes.
Question: Is it better to form my business in Delaware or stay in California?
Answer: Delaware is known for business-friendly laws, but if you operate primarily in California, you still must register as a foreign entity and pay California taxes and fees. For most small or local businesses, forming directly in California is simpler and avoids duplicative filings. Delaware formation is more common for corporations seeking venture capital or national operations.
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Final Thoughts
Choosing the right business structure is one of the most important decisions a business owner can make and it directly impacts your taxes, liability, and long-term growth. Whether you are just starting your business or considering a structural change for tax or legal reasons, it is essential to understand the federal and California-specific implications of each option.
Each structure has benefits and trade-offs, and what works for one business may not be suitable for another. Filing deadlines, tax elections, and compliance rules can be complex, so it is always wise to consult with a qualified tax professional before making a final decision. Careful planning today can help you avoid costly mistakes tomorrow.
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