List1 contains items { A, B } and List2 contains items { A, B, C }.
What I need is to be returned { C }
You simply confused the order of arguments. I can see where this confusion arose, because the official documentation isn't as helpful as it could be:
Produces the set difference of two sequences by using the default equality comparer to compare values.
Unless you're versed in set theory, it may not be clear what a set difference actually is—it's not simply what's different between the sets. In reality, Except returns the list of elements in the first set that are not in the second set.
Try this:
var except = List2.Except(List1); // { C }