An LLC conversion to S corporation is a move that some business owners decide to make in order to obtain certain benefits. While a limited liability company (LLC) and an S corporation both enjoy pass-through taxation, opting for S corporation status enables a company to reduce self-employment taxes. It also makes the business more appealing to outside investors.

Differences Between an LLC and a Corporation

Many businesses choose to adopt the LLC business structure because of its flexibility and minimal state reporting requirements. However, as their businesses grow, some of them may consider electing S corporation status, because it allows them to save on self-employment taxes and offer their companies' shares to outside investors. If they want to convert to S corporations for the sole purpose of gaining tax benefits, they can remain as LLCs and elect S corporation tax classification.

While an LLC and a corporation both protect their owners from being held personally liable for business obligations, they have different ownership and management structures. An LLC can adopt any management structure it wishes, but a corporation has a fixed management structure that consists of shareholders, directors, and officers. In addition, a corporation has more recordkeeping and reporting requirements than an LLC, and it must hold annual shareholders' meetings.

An LLC also differs from a corporation in that its membership interests are difficult to transfer. A corporation's shares can be easily transferred from one owner to another, making it a preferred option among outside investors. In order to convert to a corporation, an LLC is required to file with the state agency that is in charge of corporate filings.

Converting from LLC to S Corporation for Tax Purposes

To the IRS, an LLC is considered a disregarded entity. As such, it will be taxed as a sole proprietorship if it is a single-member LLC or a partnership if it has more than one member. Nonetheless, it can choose to be classified as a C corporation or S corporation for tax purposes. 

In an LLC, incomes and expenses are passed through to the personal tax returns of the owners. However, since the owners are considered self-employed, they are required to pay up to the annual maximum amount of Social Security taxes and Medicare taxes on the total profit of the LLC.

Similar to an LLC, an S corporation also passes its incomes and expenses through to its owners' personal tax returns. If the shareholders of an S corporation also work in the company, they will be regarded as employees. As such, they are required to pay themselves reasonable salaries, which are subject to Social Security and Medicare taxes.

Owners of an LLC can reduce their self-employment taxes if the share of profits they are currently receiving from their company is greater than the reasonable salaries they will earn after they elect S corporation status. Additionally, converting to an S corporation allows them to take tax deductions, such as deductions for owner-employee health insurance plans.

How to Convert an LLC to an S Corporation

The process of converting an LLC to an S corporation involves two steps: changing the LLC to a corporation and filing for S corporation tax classification with the IRS. It is a relatively simple process that typically requires the filing of some kind of Articles of Conversion that can serve as Articles of Corporation. Before filing, it is important to determine whether the LLC is eligible for S corporation status, since some corporations cannot be taxed as S corporations. In order to be eligible for S corporation status, an LLC must meet the following requirements:

  • Must be a domestic company
  • Must not have more than 100 shareholders
  • Must not have any shareholder that is a partnership, corporation, or nonresident alien
  • Must have only one class of stock

Once these requirements are met, the owners of the LLC can use a process called statutory conversion in many states to convert to an S corporation. In states that do not allow statutory conversion, business owners are required to undertake a more complex process called statutory merger. After successfully converting to a corporation, the company must file Form 2553 with the IRS to gain S corporation tax status.

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