Key Takeaways

  • Converting an S corporation to a single-member LLC involves legal dissolution of the corporation and creation of a new LLC.
  • A single-member LLC can be taxed as a disregarded entity, partnership (if it gains partners), C corporation, or elect S corporation status.
  • EIN reassignment by the IRS is not guaranteed in conversions and may require obtaining a new EIN.
  • State laws vary widely; some states lack conversion statutes, necessitating alternative restructuring methods.
  • The process may have significant tax implications, including potential gain recognition and payroll tax adjustments.
  • Proper planning is essential to meet IRS and state requirements for maintaining compliance and favorable tax status.
  • Legal counsel can help navigate merger alternatives, S corporation eligibility, and employment tax implications.

To convert S corp to single member LLC involves the conversion of a state law corporation to a limited liability company with only one owner. It doesn't mean that your EIN is automatically retained (i.e. carried over to the LLC). The IRS only reassigns a corporation's EIN to the successor LLC…only in certain situations.

Disregarded Entity Tax Status

For many companies in the U.S., the LLC has become an important component of their state and federal tax planning.

Once a state law corporation is converted to an LLC, losses that were locked in the corporation may be used to offset income if the LLC is granted a disregarded entity tax status for federal tax purposes. This status could also simplify tax filings for the company owner(s).

Companies that are thinking of converting their corporate subsidiaries into LLCs should determine if their EINs will be transferred to the LLC before they file a state conversion document.

If the predecessor corporation's EIN was used to obtain state registrations and licenses and file state and federal employment tax returns, the cost of obtaining a new EIN for the limited liability company may be substantial.

For instance, the payroll service used by the company would need to implement a new database for entities with a new EIN, which would be costly and time-consuming. Furthermore, for entities that are eligible for Medicaid and Medicare reimbursements, an interruption of their EINs would mean significant delays in receiving such reimbursements.

When to Consider S Corp Election for a Single Member LLC

A single-member LLC may elect to be taxed as an S corporation to take advantage of potential tax savings on self-employment taxes. The primary benefit of this election is that the owner can treat a portion of the income as a salary (subject to payroll taxes) and the remaining as distributions, which are not subject to self-employment taxes.

However, the IRS requires the owner to pay themselves a "reasonable salary," which must be reported and taxed via payroll. If the salary is deemed unreasonably low, the IRS may recharacterize distributions as wages, leading to penalties.

This option is best suited for LLCs with consistent profits exceeding the reasonable compensation threshold, typically above $40,000–$50,000 in annual net income. Electing S corp status also means additional administrative tasks such as:

  • Filing IRS Form 2553 to make the S corporation election.
  • Setting up payroll and withholding employment taxes.
  • Filing a corporate tax return (Form 1120-S).
  • Maintaining accurate corporate minutes and separate financial records.

Avoiding Income Taxation at the Entity Level

Although a single member LLC with a disregarded entity tax status is treated as a corporation for excise tax and employment tax filing purposes, it avoids income taxation on the entity-level.

This means that single-member LLCs that are liable for excise tax or have employees must have its own EIN for filing Quarterly Federal Excise Tax Return, Forms 720, 940, and 941, and Employer's Quarterly Federal Tax Return.

State law corporations who use their EINs to file federal tax returns and payments usually prefer to retain the EIN when they convert to an LLC, whether the LLC is a partnership, an entity taxed as a corporation or a disregarded entity.

Legal and Structural Considerations in Conversion

Converting from an S corporation to a single-member LLC is not merely a tax election—it involves dissolving the S corp and forming a new legal entity under state LLC statutes. This distinction is critical because:

  • The conversion may trigger tax consequences, including recognition of built-in gains or liquidation events.
  • Existing contracts and licenses may need to be reassigned or renegotiated.
  • Bank accounts must be updated to reflect the new entity structure.
  • In some states, a statutory conversion simplifies the process, while in others, a merger or asset transfer may be required.

Business owners should consult with legal counsel to ensure compliance with state statutes, including filing Articles of Conversion (if applicable), amending operating agreements, and updating registered agent information.

Selection of Federal Tax Classification

Due to the regulations contained in Regs. Secs. 301.7701-1 -3, eligible business entities are allowed to select their federal tax classification. Conversions from a state law corporation to an LLC means converting from an entity that can only be classified as a corporation to one that can choose its federal tax classification or default to the classifications described in Regs. Sec. 301.7701 -3 (b)(1).

Since the formation of an LLC occurs under state law, the IRS' decision on whether or not to reassign the corporation's historic EIN to a newly formed LLC is based on the same law.

Steps for Electing S Corporation Status After Conversion

If a business converts from a state law corporation to a single-member LLC and wants to be taxed as an S corporation, the following steps are required:

  1. File Form 8832 (Entity Classification Election) to elect corporate tax treatment.
  2. File Form 2553 (Election by a Small Business Corporation) to elect S corporation status.
  3. Ensure the LLC meets the eligibility requirements for S corp status:
    • Must be a domestic entity.
    • Only allowable shareholders (e.g., individuals, certain trusts).
    • No more than 100 shareholders.
    • Only one class of stock (or equivalent member interests).
  4. Begin paying the owner a reasonable salary and setting up payroll systems.

The timing of these filings is crucial. Generally, Form 2553 must be filed no more than 2 months and 15 days after the beginning of the tax year in which the election is to take effect, or at any time during the tax year preceding the tax year it is to take effect.

Differences between Mergers and Conversions

The IRS delineates between a state law merger of a surviving LLC with a corporation and the conversion of a state law corporation to an LLC.

A merger is a joining of two distinct legal entities while a conversion involves changing a business' legal status.

Ordinarily, the IRS reassigns a corporation's EIN to the successor LLC if the conversion happens under state law; however, the requirements and steps are based on said local law. Tax advisers should not assume that state tax filings for a conversion of corporations that occurred in different states are the same.

For instance, the tax filings for a California conversion may be different from that of a Delaware conversion.

Also, there are states with no conversion statute — meaning that it isn't possible to convert corporations to LLC in such a state. In such a scenario, companies that want to re-organize into a single-member LLC (under the state's LLC statute) should

  • Form a single-member LLC under the LLC statute of the state.
  • Classify the LLC as a corporation effective from the formation date (initial election) by filing Form 8832…Entity Classification Election.
  • Merge the LLC with the corporation (with the LLC as the surviving entity) under Sec. 368(a)(1)(F).

Rev. Rul. 73 - 526 stipulates that a predecessor corporation's EIN will be reassigned to the successor corporation in a reorganization that involves only a change in form, identity or place of organization.

The LLC may file another Form 8832 to assume a disregarded entity tax status.

Alternative Approach When State Law Doesn’t Permit Conversion

In states that do not provide statutory conversion options, a company must take a more indirect approach to restructure an S corporation into a single-member LLC:

  1. Form a new single-member LLC in the desired state.
  2. Elect corporate tax classification for the new LLC using Form 8832.
  3. Merge the existing S corporation into the new LLC, treating the LLC as the surviving entity.
  4. File a Section 368(a)(1)(F) reorganization, treating the transaction as a change in identity or form—this allows potential continuation of the EIN and tax history.

This approach can help preserve the business's operating continuity while complying with tax and legal requirements, but it must be executed carefully to avoid IRS scrutiny and unintended tax consequences.

Potential Risks and Pitfalls of Converting to or from an S Corp

While a single member LLC to S corp conversion can offer tax advantages, there are notable risks:

  • Loss of Flexibility: S corporations have rigid ownership rules, which may limit future investors or reorganization options.
  • Increased Complexity: Running an S corp requires more recordkeeping, payroll compliance, and legal formalities compared to a disregarded entity.
  • Employment Tax Risks: Improper classification of compensation vs. distributions can trigger IRS audits or penalties.
  • Asset and Liability Transfers: When converting from S corp to LLC, all assets and liabilities are deemed transferred, potentially resulting in gain recognition.

A thorough review with legal and tax professionals is essential before initiating any changes to avoid missteps that could result in costly consequences. UpCounsel connects businesses with experienced attorneys who can help navigate these transitions.

Frequently Asked Questions

1. Can a single-member LLC elect to be taxed as an S corporation? Yes. A single-member LLC can file Form 2553 with the IRS to elect S corporation taxation, assuming it meets all eligibility criteria.

2. Do I need a new EIN when converting from an S corp to an LLC? Not always. The IRS may allow the existing EIN to be used in a conversion if the LLC is the successor entity and meets specific requirements. Otherwise, a new EIN is required.

3. What’s the difference between converting and merging a business? A conversion changes the entity type under state law, while a merger combines two entities with one surviving. Some states only permit restructuring via merger.

4. Is it always beneficial to convert to an S corporation? Not necessarily. While S corp status can reduce self-employment taxes, it also introduces more complexity and restrictions. Evaluate your income level and long-term goals before deciding.

5. How long does it take for an S corporation election to take effect? If Form 2553 is timely filed, the S corp status can begin at the start of the tax year. Late elections may be accepted under certain IRS relief provisions.

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