Changing From S Corp To LLC: Everything You Need to Know
When changing from an S-corp to LLC, there are some key steps you need to take. 3 min read
2. Converting S-Corp to LLC: General Procedures
3. Variable Elements of Conversion
4. Converting S-Corp to LLC: Tax Consequences
5. Converting S-Corp to LLC: Advantages
Converting S-Corp to LLC
You will enjoy limited liability whether you are a limited liability company (LLC) or an S-corp. Although neither of these structures are taxed at the federal level, S-corps are taxed on certain types of passive income. Since LLCs benefit from fewer formalities, simplified operations, and more flexible tax options, you may be interested in turning your S-corp into an LLC.
The process to do so will vary from state-to-state. In the majority of cases, you will need to file a simple form with the Secretary of State. However, in other cases, this procedure can be more complex. If your state requires you to form an LLC and then merge your S-corp into your limited liability company, you may want to seek a professional opinion.
Converting S-Corp to LLC: General Procedures
In order to initially authorize conversion, a corporate resolution will be required. In the majority of states, this decision typically needs to be unanimous. Once all shareholders have agreed, you can begin conversion.
You will need to do one of the following:
- File a Certificate of Conversion or its equivalent.
- Complete a merger.
For example, here is a Certificate of Conversion for the state of Tennessee.
Once you do convert your business from an S-corp to an LLC, you will need to inform the IRS.
Depending on your state, this conversion can be completed by forming a new LLC and merging the S-corp into the new business structure. In this case, the LLC will be a survivor in the merger. Since there can be tax consequences associated with the liquidation of an S-corporation, it is imperative that you understand your options.
Variable Elements of Conversion
Before you begin this process, know that there is more than one type of corporation, more than one tax status for an LLC, and more than one kind of conversion. C-corporations, for instance, pay corporate taxes, whereas S-corporations benefit from pass-through taxation. This means that only the shareholders pay taxes, not the corporation itself.
Other potential variables include the following:
- Where your corporation was formed, as state regulations and tax laws vary
- Whether your LLC will be a single-member or multi-member entity
- Whether your LLC will be taxed as a corporation, partnership, or "disregarded entity"
- How you plan to convert your business (i.e. statutory conversion vs statutory merger)
Converting S-Corp to LLC: Tax Consequences
Before you begin the conversion process, be aware of the possible tax consequences.
- If your S-corp increases in value within the period between its formation and the conversion to an LLC, shareholders will be subject to capital gains tax.
- In some states, this conversion is not a simple process. If you do not want to deal with the complications associated with a merger, you may have the option to liquidate the S-corp. That way, all assets will be transferred to shareholders who will then contribute these assets to the newly formed LLC. In this case, Code Section 331 will apply, whereas Code Section 301 and Code Section 1368 will not.
Other disadvantages include potential tax liability to the shareholders of a former S-corp and more complicated taxation for single-owner LLCs. If you own a single-member LLC, you will need to report your taxes on Schedule C of your individual tax return instead of on Schedule E in relation to an S-corp. Experts also agree that as you increase the amount of reported income on Schedule C, you are more likely to be audited.
Converting S-Corp to LLC: Advantages
Although you will want to become familiar with the possible consequences of conversion, there are also a number of advantages, including the following:
- Certain corporate formalities, which do not apply to an LLC, are eliminated.
- An LLC can file for S-corp election for tax purposes.
- Members are protected from creditors by the "changing order" statutes. For companies that own a significant amount of assets, this is a valuable advantage.
If you need help changing from an S-corp to an LLC, 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.