Part of the appeal of an LLC as a business entity is its flexibility, but even with the versatility offered you might at some point need to change your LLC into an S-corporation. Fortunately, there is a process in place to allow you to do so. But before you make a final decision, it’s important to understand the differences between LLCs and S-corporations, the tax implications of making the switch, the requirements you need to meet in order to be eligible, and the steps you need to take in order to make the change.
LLC vs S-Corp
Both LLCs and S-corps serve as separate entities that shield their members or shareholders against liability for the debts of the business, and while either allow for their members/shareholders to pass through business profits to individual tax returns, they differ from there in how they are owned and managed.
In forming an LLC, a business can have as many members of the LLC as they choose, and those members can reside anywhere in the world. Members don’t even need to be individuals; another entity can take ownership in an LLC S-corps on the other hand, are limited in which individuals can own shares, and the number of shareholders. Under the rules governing S-corps, there can only be up to 100 shareholders, and those shareholders must be U.S. citizens.
Within an LLC, members choose managers to handle the day-to-day operations, either from outside the business or from their own ranks. S-corps elect a board of directors, who in turn choose officers responsible for the daily management of the business.
S-corps can change ownership more easily than LLCs. Because S-corps are able to issue stock (albeit only common stock) they can easily sell shares to new investors, or current shareholders can sell their shares to others, provided that the buying party meets the ownership standards of an S-corp. With LLCs, there are no shares to sell or transfer, instead there are membership units and changes in ownership may require the approval of all the other members.
Although both LLCs and S-corps enjoy the benefit of pass-through taxation, there are additional tax benefits to be gained in being taxed as an S-corp. Members of an LLC are required to pay self-employment taxes on the profits they derive from the business whereas, S-corp owners can avoid paying those taxes directly by electing to be employed by the S-corp and paid a salary. The taxes paid into Social Security and Medicare are withheld and paid on that salary, with any corporate earnings beyond that not subject to self-employment tax.
A complication of this approach is that, for the purposes of retirement plans, contributions to a 401(k) can only be made from earned income. So if you’re looking to avoid taxes by keeping your salary low while keeping other corporate earnings high, your retirement account could take the hit.
What Are the Requirements to Change My Business From LLC to S-Corp?
In order to convert an LLC to an S-Corp, you need to make sure that your business meets the standard that is applied to S-corps, which means that
- Your business needs to be based in the U.S.
- There are less than 100 shareholders, and all of them are U.S. citizens
- You only have one class of stock
How to Convert LLC to S-Corp
If you’re looking to change your LLC to an S-corp for tax purposes only, your LLC will need to file IRS Form 2553 either during the calendar year prior to the year you wish the change to take effect, or before March 15th if it’s that same year. This is an area to seek the assistance of a LegalShield provider lawyer.
Changing the actual structure of your entity from that of an LLC to an S-corp requires a statutory conversion. Provided that you meet the same requirements listed above for na S-corp and your state allows for statutory conversions, you can complete the process by filing a certificate of conversion with the state and paying the requisite fees that go along with it. Provided that everything is in order and approved, your LLC’s assets and debts are transferred over to your new S-corp. It may sound simple but this transaction will likely require legal and accounting expertise.
If statutory conversion isn’t available, you can elect to try a statutory merger, wherein you create a S-corp with your LLC members as shareholders and create a plan of merger that turns their interests in the LLC into shares in the new corporation. You can then file a certificate of merger with the state along with the necessary forms for dissolving the LLC. Again, seek help from a LegalShield provider.
Why Choose LegalShield When Switching From LLC to S-Corp
Trying to make changes to your tax status or your business entity is complex work, and isn’t the sort of task on which you can afford to make mistakes. Work with a LegalShield provider lawyer on your business formation or business conversion matters to get the advice and help you need at a price you can afford.