Changing from LLC to S Corp

Changing from an LLC to an S corp can be beneficial for some business owners. With that said, a lot of small businesses choose to form an LLC rather than a corporation due to the flexibility and fewer formalities in terms of reporting requirements. If, however, you decide that the corporation is a better business structure for you, then you can simply convert your LLC to an S corporation.

Keep in mind that if you want to change to an S corp for the tax benefits, you can still continue operating as an LLC, but elect to be taxed as an S corp.

LLC to S Corp for Tax Purposes

The Internal Revenue Service (IRS) does not recognize LLCs as entities. If an LLC fails to elect to be taxed as a different business structure, then the default rules will apply. Therefore, if one person chooses to form an LLC, he or she will be taxed as a disregarded entity. This means that the LLC will be taxed as a sole proprietorship, and the owner (member) will report the profits and losses of the LLC on his or her personal tax return. It also means that the owner will pay Social Security and Medicare tax. If a multi-member LLC fails to elect to be taxed differently, then it will be taxed as a partnership.

Benefits of an S Corp

There are many benefits to operating as an S corp, including:

  • Saving on self-employment tax
  • You can contribute additional money to your retirement account
  • Additional tax deductions

One of the tax benefits of operating an S corp over an LLC is the savings on self-employment taxes. Members of an LLC must pay a 15.5 percent self-employment tax, whereas S corp shareholders only pay Social Security and Medicare taxes on the salary that they receive from the corporation. Owners of C corporations pay corporate income tax as well as personal income tax on any distributions made to owners.

Another advantage of an S corp is the fact that you are able to contribute more money to a retirement account because you can set up an individual 401k. Generally,people with an annual income of less than $120,000 are able to contribute up to $5,500 to their Roth IRA or 401k. With the solo 401k, you are able to contribute as much as $18,000 to an individual Roth 401k. Additionally, you are able to contribute up to another $36,000 to the solo 401k. This will depend on your salary, and so long as you earn at least the total amount of money you are putting in, then you can contribute that same amount up to $54,000.

Older professionals (meeting a certain age requirement) can contribute additional amounts, depending on the state. The more you contribute, the less of a tax burden you will have.

Another benefit of an S corp (as well as a C corp) is the additional tax deductions that owners can take, including deductions for health insurance.

When to Convert from an LLC to an S Corp

There are several instances when it would be beneficial for you to convert your LLC to an S corp, including when self-employment tax is greater than the amount of tax that would be paid if operating as an S corp. Therefore, if your LLC has $40,000 net profits, you should convert an S corp.

LLC members must pay self-employment tax, usually equivalent to the amount contributed into the LLC in the first place. The reason for this is because the LLC operates as a pass-through tax entity, which means that the members will report the profits/losses on their own personal tax return, but only to the extent of capital that they contributed to the LLC. This self-employment tax can be quite high. However, owners in an S corp can pay themselves a reasonable salary, which means that the owner will only have to pay social security tax and Medicare tax, the same way in which all employees are taxed.

If you need help converting your 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.