It's possible to convert your LLC to an S corp., but before you take that step, it's wise to consider what you hope to gain from it. A limited liability company and an S corporation share certain important characteristics, chiefly the protection their owners (or members) enjoy from liability for the company's obligations and their status as pass-through entities. But if it's tax benefits you desire, you can achieve that result without having to revamp your company's structure.
S Corp. Tax Benefits
By default, the Internal Revenue Service (IRS) treats LLCs as disregarded entities for tax purposes. Therefore, a single-member entity pays taxes as a sole proprietorship whereas a multiple-member entity pays taxes as a partnership. If you are a member, this method leaves you liable for self-employment taxes, including Social Security and Medicare tax. These taxes can be hefty if your business is profitable.
If, however, you are a shareholder in an S corp., you can divide your distributions from the business into salary and dividends and have the company pay employment taxes on your salary. You thereby save money on employment taxes.
Electing S Corp. Tax Treatment
You can choose to have your LLC treated as an S corp. for tax purposes without actually converting it, as long as your company meets IRS requirements by following these steps:
- File an Entity Classification Election form (Form 8832) with the IRS, electing to have your company taxed as a corporation instead of a sole proprietorship or partnership.
- Next, file an Election by a Small Business Corporation form (Form 2553)
Electing S corp. tax treatment may be your best course of action because you can avoid other requirements that apply to corporations, such as having a board of directors, written bylaws, and regular directors' and shareholders' meetings. It also saves you the expense of conversion.
Be aware that you cannot elect such treatment unless your business complies with certain IRS rules. First, although there are few legal limitations on an LLC's membership, an S corp. can have only allowable shareholders; their shareholders cannot be partnerships, corporations, or nonresident aliens. Additionally, the company must be a domestic corporation, have no more than 100 shareholders, have only one class of stock, and not be ineligible for such status (e.g., certain financial institutions or insurance companies).
Converting to an S Corp.
If you have reasons other than the tax benefits for wanting to convert your business, the process for doing so is simple in some states—but not so simple in others. First, you must be sure your company meets the S corp. requirements detailed above. Next, be sure you have consent from all members. If you are in a particularly business-friendly state, you may be able to take advantage of statutory conversion. This process allows you to complete the conversion process by simply filing the appropriate forms with the state and paying the necessary fees. Note that the forms and fees vary by state.
Other states permit a statutory merger. For this, you create a new corporation and then follow the statutorily prescribed process for merging that corporation with your LLC. In the remaining states, however, there is no simple statutory process for effecting the conversion. Consequently, the procedure is more complicated and requires not only creating a new corporation but also formally dissolving your business.
Creating an S corp. from the beginning, rather than forming an LLC and later converting it, does not have to be complicated or expensive. Follow this guide to better understand how to complete the conversion process and maintain your business needs.
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