1. LLC vs. S Corporation
2. Corporation Taxation Benefits
3. How to Convert an LLC to an S Corporation
4. When to Convert LLC to S Corporation

Updated November 26, 2020:

If you wish to change from LLC to S-corp, it can be a complex process with quite a few steps. However, this process is necessary for anyone who wants to take their business to the next level with S-Corp status. A limited liability company is one of the most common forms of business in the country, but that type of organization doesn't work as well if the business grows too much. 

An LLC or a limited liability company is created through state law and is designated through federal tax laws. An LLC is distinct from a corporation unless forms are filed to change its designation. 

An S corporation is a bit different in that it passes all income, credit, deductions, and losses to shareholders. S corporations are for-profit and have to be designated as such through the IRS. The S corporations themselves don't pay taxes; instead, they file a return showing net gain or loss. That information is funneled through the shareholders. It's important to note that no corporation can be founded as an S corporation. It can only be granted that status by requesting the designation from the IRS.

LLC vs. S Corporation

Both an LLC and an S corporation are types of business entities, but they vary in the way they are run. Remember, the only difference between a C corporation and an S corporation is the way income tax is determined. No matter which type of organization you run, you still have limited personal liability for business obligations. The difference is in the management structure. 

An LLC can be run essentially however you want, while a corporation has a board of directors. Corporations have to report more of their business information, and they have to host meetings for shareholders. A corporation designation also makes it much easier to transfer shares. They can be traded easily, which attracts outside investors. An LLC doesn't have those requirements, making it difficult for outsiders to get involved.

Corporation Taxation Benefits

S corporations can enjoy some tax benefits compared to regular corporations, such as being able to avoid the double-taxation issue. The owners are treated as employees, so they just get payroll taxes taken from their income. LLCs, on the other hand, don't actually have their own federal income tax classification. The IRS just taxes any single-member LLC as a sole proprietorship and a multi-member LLC like a partnership

When an LLC classifies itself as an S corporation, it can be taxed as such, which could be more beneficial. Since LLC owners are taxed as self-employed individuals, electing to have S corporation status could cut down on those taxes, since they save if their share of the profits is larger than their reasonably earned salary. This is due to the Foreign Earned Income Exclusion. S corporations can also set up 401(k) retirement accounts, which cuts down on taxes even more.

How to Convert an LLC to an S Corporation

If you're trying to convert an LLC into an S corporation, you'll have to convert to a corporation first, then apply for an S corporation designation through the IRS. There are a few requirements your business must meet if you want to qualify for S corporation status.

  • Must be domestically based
  • Must have fewer than 100 shareholders
  • No shareholders can be a corporation, partnership, or nonresident alien
  • Must only have one class of stock available

If these qualifications are met, many states allow for the statutory conversion process. This allows you to simply transfer the assets to the new classification rather than having to dissolve the LLC. For this, all you have to do is file the correct forms, which are commonly found on the state's website.

States without this process require statutory mergers. This process is a bit more complicated.

  • The corporation must be formed with members of the LLC as shareholders
  • Shareholders swap membership in the LLC for shares in the corporation
  • Must file the required documents
  • Must formally dissolve the previous LLC
  • Must file Form 2553 to obtain S corporation designation from the IRS

When to Convert LLC to S Corporation

The deadline for a classification change is March 15 for the status to take effect the following year. Whether or not it's the right decision depends on your taxes. If self-employment taxes are more costly than an S corporation's tax burdens, it's probably a good idea to change your LLC to an S corporation.

If you need help with changing from an LLC to an S-corp, you can post your legal need on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.