Convert S Corp To LLC: Everything You Need to Know
Both limited liability companies (LLCs) and S-corporations operate with limited liability, and neither are taxed at the federal level. There are some exceptions in S-corporations regarding passive income. 3 min read
2. Converting S-Corp to LLC: General Procedures
3. Various Elements of Conversion
4. Converting S-Corp to LLC: Tax Consequences
5. Converting S-Corp to LLC: Advantages
Updated November 27, 2020:
To convert an S-corp to an LLC, you will need to take key steps based on your state's regulations:
- Obtain shareholder authorization as required by your state.
- File a Certificate of Conversion or, in some states, form an LLC and complete a merger.
Converting S-Corp to LLC
Both limited liability companies (LLCs) and S-corporations operate with limited liability, and neither are taxed at the federal level. There are some exceptions in S-corporations regarding passive income.
There are several benefits associated with forming an LLC, including the following:
- Simplified operations
- A reduction in formalities
- Flexible tax options
In comparison to S-corporations, LLCs are easier to manage and are less formal in terms of recordkeeping. There is also greater flexibility among shareholders. While S-corporations can have no more than 75 owners, LLCs can have an unlimited number of shareholders.
If you are currently operating an S-corporation and would like to convert to an LLC, it is certainly possible. Depending on your state, you will need to do one of two things:
- File for a merger.
- Notify the state that your corporation will be changing its status.
In many states, you will be required to complete a form and file with the secretary of state. In other cases, you will need to form your LLC and then merge your S-corp into this new entity. If this is the option you have, know that this conversion can be rather complex.
Converting S-Corp to LLC: General Procedures
If you are planning to convert your S-corporation to an LLC, you will require authorization from all shareholders. Since there may be tax-related ramifications, most states require a unanimous decision. Once you do agree, you can begin the conversion process. This will require you to either complete a merger or file a Certificate of Conversion.
You will then need to notify the IRS. Also, be mindful that S-corporation shareholders may need to pay tax on the liquidation of the corporation itself. This is what's known as capital gain tax. In comparison to C-corporations, the following is true of S-corporations:
- They are only subject to one level of tax.
- They should be careful when moving the S-corporation's stock to the LLC
Overall, this conversion can be fairly complicated, and proper due diligence is required. In some cases, seeking legal counsel is highly recommended. This is particularly true when liquidating a corporation.
Various Elements of Conversion
Before you begin this process, know that there is more than one possible tax status for an LLC, more than one kind of corporation, and more than one type of conversion.
- There are C-Corporations, which pay corporate taxes. There are also S-corporations, which enjoy pass-through taxation.
- Corporations are also formed under differing state laws.
- LLCs can have one owner or "member," or they can also have multiple members.
- Multi-member LLCs may be taxed as a partnership, as a "disregarded entity," or as a corporation.
- When converting, you can do so via a statutory conversion, a non-statutory conversion, or a statutory merger.
With various options, not all conversions are considered to be fundamentally equal.
Converting S-Corp to LLC: Tax Consequences
Before you complete a conversion, understand that there may be tax consequences. Regardless of the method of conversion, the IRS will still view this process as an S-corp liquidation. Shareholders may also be subject to capital gain tax. If your conversion will not be a straightforward process, it's best to seek advice from your attorney before making any significant changes.
Converting S-Corp to LLC: Advantages
Once a conversion is complete, many of the corporate formalities associated with an S-corporation will be eliminated. As an LLC, you can enjoy greater flexibility in terms of management and greater taxation options. You will automatically be taxed as a partnership (for multi-member LLCs) or a sole proprietorship (single-member LLCs). However, you also have the option of S-corporation election.
Within most states, LLC owners are also protected from what's known as "changing order" statutes.
If you believe that converting from an S-corp to an LLC is the best move for your business, become familiar with your state's requirements. You should also familiarize yourself with the types of status conversions and what they mean in terms of taxation.
If you need help with converting 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.