When you want to convert LLC to C corp California makes it a relatively easy process, though it can require several steps and some paperwork. An LLC, LLP, or GP in California can convert to another business entity or other foreign business entity as long as the foreign jurisdiction allows for it. The only exception is a California corporation cannot convert to a foreign entity.

Steps Required to Convert a C Corp to an S Corporation

Converting from a C corporation to an S corporation requires a few simple steps, but it can be easier with the help of a lawyer or tax professional to make sure all of the requirements are met. Some of the steps you will need to follow include:

  • Filing a Form 2553 with the Internal Revenue Service.
  • Making sure that the form is signed for by all of the company shareholders.
  • Submitting the form within the two months and 15 days after the beginning of the tax year that you want the S corporation tax election to be made.
  • Filing a Form 1120S for the tax year that the S corporation filing has been made.

What Tax, Legal, and Financial Considerations Do You Need to Consider When Converting a C Corp?

When converting any California C corporation to an S corporation designation, the biggest consideration is the change in tax status. In the beginning, all corporations will start off as a C corporation and will need to go through the process of choosing the S corporation designation.

Once the articles of incorporation have been filed, your bylaws have been enacted, the shares have been issued, and the first shareholder meeting has been held, then the California C corporation can decide to become an S corporation. If you do not decide to file as an S corporation in the first 45 days of forming your corporation, then it will stay a C corporation for tax purposes until the filing of the S corporation has occurred.

Additional Considerations to Make When Converting to an S Corporation

There are many other considerations to take into account before converting your C corporation to an S corporation. Some things you will need to take into account include:

  • Pass-Through Taxation - When you convert from a C corporation, you will be changing from an independent tax entity to a pass-through entity.
  • Built-In Gains - Within five years of converting your C corporation to an S corporation, the IRS will impose a 35% tax on the gains that you received as sales of the C corporation assets that were then distributed to an S corporation. This can even apply if there were no assets sold and will be applied to the accounts receivable that were collected by the S corporation.
  • Passive Investment Income Taxes - You may also be subject to taxes on any passive income investments that were inherited by the S corporation from the C corporation. If the income is in excess of the S corporation's gross income, it can be subject to a special tax. To avoid this tax, you can distribute the passive income to the S corporations shareholders where it will then be reported on their personal tax returns.
  • FICA and Self-Employment Taxes - When converting to an S corporation, it is important to create reasonable dividends and salaries to minimize the self-employment and FICA taxes that you might be subject to.

Differences Between a C Corporation and an LLC

The differences between regulation may sway your decision when choosing between a C corporation and an LLC. It may be easiest to start your business as an LLC, but consider changing to a C corporation if you want to be more competitive when hiring employees or seeking out investors.

Venture capitalists will gravitate towards investing in C corporations because of the ability to take ownership of shares. Investors are even more attracted to Delaware C corporations because of the ability to gain preferential shares. Additionally, if the venture capitalists are investing in public funds, these can not go towards the funding of LLCs

C corporations are also ideal for investors because they allow for more seamless calculation for the distribution of the owned equity in C corporations. This is not only a factor that is important to investors but to potential employees as well.

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