Can I Convert an LLC to an S-Corp?

By William Pirraglia

Converting an LLC to an S corp is possible, but should be done carefully. The advantages of each business structure are offset by potential disadvantages. From a tax treatment perspective, the advantages and ramifications are roughly equal. However, from an company expansion point of view, the differences can be important. In all cases, conversion will come with some expenses that are unavoidable.

LLC and S Corp Similarities

LLCs and S corps are similar in tax treatment. S corps are "pass through" organizations, whereby owners, known as stockholders, receive shares in profits directly proportionate to their ownership percentage, based on the number of shares owned. Neither S corps nor LLCs need to pay taxes on their earnings as profits are distributed to owners as personal income.

LLC and S Corp Differences

S corps are standard corporations whose stockholders have chosen to have their company become a "pass through" organization. Profits and losses are delivered to stockholders. However, S corp regulations mandate that they have 100 shareholders or less, all of whom must be U.S. citizens or documented resident aliens. LLCs have no such ownership restrictions. LLCs can accept investment from foreign investors. However, as standard corporations, with only tax treatment differences, S corps can evolve into publicly traded entities, whereas it is exceedingly difficult and often impossible for this to occur with an LLC.

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Reasons for LLC to S Corp Conversion

While there are few motivators to convert an LLC to an S corp, the potential reasons are important. Primary reasons to convert an LLC to an S corp are tax benefits and flexibility to grow. The major tax benefit with an S corp is the ability to designate some profit as salary and some as dividends. Payroll taxes on salary can be paid through the corporation. This saves money in self-employment taxes. While restricted to 100 shareholders, the corporation structure, with stock ownership, offers more flexible ways to get more investment and grow the company.

Maintenance Requirements with a Corporation

Converting your LLC to an S corp involves additional administrative duties. Corporation law requires naming a board of directors, holding regular recorded meetings, writing and updating bylaws, and other state-mandated requirements. Other than additional paperwork, you should not face other detriments. The potential for double taxation is eliminated by electing S corp tax treatment. Therefore, all the benefits of a corporation combined with the individual tax treatment of an LLC may make it worthwhile to complete the added paperwork required for a corporation.

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What Forms Do I Need to File for an S Corp?

An incorporated business is automatically designated by the Internal Revenue Service as a C corporation for income tax purposes. However, certain smaller corporations can elect to be taxed as S corporations without forfeiting the liability protections that the corporate structure affords to shareholders. Making the initial election requires filing an IRS form. Once S corporation status is granted, the tax forms the corporation must file annually will change.

LLC Vs. Inc.

People often confuse LLCs (limited liability companies) with corporations (Inc.). They are, at first glance, similar, yet very legally different. The two business structures do share one very important feature -- limited liability for owners. However, many other components are different. While one choice is not "better" than the other, one option may be more appropriate than the other in certain circumstances. An Inc is seldom an inappropriate choice, but can be more expensive or tedious to maintain than an LLC, from a paperwork perspective.

S Corporation Conversion to LLC

It is possible to convert an S corp to an LLC. Some states have no published specific procedure, while other jurisdictions state the process clearly. In those states with official procedures, the process is quite simple. In some states, you simply notify the appropriate agency, usually the secretary of state, stating that you wish to change your company structure from a corporation to an LLC. In other states, you may need to merge the companies and liquidate the S corp.

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