Business team discussing convert LLC to S-Corp
Business team discussing convert LLC to S-Corp

How to convert an LLC to an S-Corporation

Converting a Limited Liability Company (LLC) to an S-Corporation (S-Corp) can offer several advantages for business owners, including tax savings. However, before you make any permanent changes, you’ll need a careful understanding of the legal and financial implications.

In this article, we’ll explore the key aspects of converting an LLC to an S-Corp, including the benefits, potential advantages and disadvantages, and the steps involved.

Can I turn my LLC into an S-Corp?

Yes, you can convert your LLC into an S-Corp. The process involves electing S-Corp status with the Internal Revenue Service (IRS) while maintaining your existing LLC structure. This election changes the tax treatment of your business without altering its legal entity status. However, you must meet certain requirements—you must be a U.S. business, have no more than 100 shareholders, and can only issue one class of stock. Shareholders may be individuals, certain trusts, and estates, but can’t be partnerships, corporations, or nonresident aliens.

The real question here is not whether you can convert an LLC to an S-Corp, but whether you should. Let’s take a look at the factors involved.

What are the benefits of converting from an LLC to an S-Corp?

Many business owners hear that there are big benefits to converting to an S-Corp, and that’s true in some cases. Here are some of the potential benefits: 

  • Tax savings: One of the primary reasons for converting to an S-Corp is the potential for tax savings. LLCs are typically subject to self-employment taxes on the entire net income of the business. By converting to an S-Corp, owners can classify some of their income as salary (which is subject to payroll taxes), and the remainder as distributions (which are not subject to self-employment taxes).
  • Pass-through taxation: Like LLCs, S-Corps benefit from pass-through taxation. The business is not taxed at the corporate level. Any profits or losses from the business are reported on the owner’s personal tax return instead, potentially lowering overall tax liability.
  • Limited liability protection: Both LLCs and S-Corps offer limited liability protection, which shields the owner’s personal assets from business debts and liabilities.

Should I convert my LLC to an S-Corp?

Deciding whether to convert your LLC to an S-Corp depends on several factors, including your financial situation and long-term goals. Here are some of the factors we take into account when helping a client decide whether to convert.

  • Tax advantages: If your business is generating significant income, the tax savings from reducing self-employment taxes can be substantial.
  • Administrative burden: S-Corps require more rigorous compliance and record-keeping compared to LLCs. Ensure you’re prepared to handle these additional responsibilities.
  • Ownership structure: If your business plans to attract investors or distribute ownership more broadly, the corporate structure of an S-Corp might be advantageous.

We recommend consulting with a tax professional in order to get personalized advice for your specific circumstances—there isn’t a one-size-fits-all decision tree for converting from an LLC to an S-Corp.

What is the difference between a C-Corp and an S-Corp?

Understanding the differences between a C-Corporation (C-Corp) and an S-Corp is essential when considering the best structure for your business:

  • Taxation: C-Corps are subject to what is considered double taxation. The corporation will pay taxes on its income, and the shareholders pay taxes on dividends. S-Corps avoid double taxation by passing income directly to shareholders to be taxed at individual rates.
  • Ownership restrictions: S-Corps have restrictions on the number and type of shareholders (no more than 100, all must be U.S. citizens or residents), whereas C-Corps have no such restrictions.
  • Stock classes: S-Corps can only issue one class of stock, limiting flexibility in profit distribution. C-Corps can issue multiple classes of stock.

What happens when an LLC converts to a corporation?

When an LLC converts to an S-Corp, the business’s legal structure remains largely the same, but its tax classification changes. The primary changes include:

  • Tax treatment: Post-conversion, the business will be taxed as an S-Corp instead of an LLC. Owners will receive W-2 wages, and any remaining profits will be distributed as dividends.
  • Corporate formalities: The S-Corp may need to adhere to certain rules, such as holding regular board meetings and maintaining corporate minutes.
  • Employee classification: Owners who work in the business are treated as employees and must be paid a reasonable salary, subject to payroll taxes.

Disadvantages of converting LLC to S-Corp

While there are many benefits, there are also potential drawbacks to consider.

  1. Increased complexity: Running an S-Corp involves more administrative complexity and stricter compliance requirements compared to an LLC. You’ll be required to maintain corporate records, hold shareholder meetings, and follow corporate governance protocols.
  2. Salary requirements: S-Corp owners must be paid a reasonable salary, which can complicate payroll processes and potentially increase payroll tax liability.
  3. Limited flexibility in profit distribution: Unlike LLCs, S-Corps can only have one class of stock, which limits the flexibility in distributing profits and losses among owners.
  4. Credibility and attractiveness to investors: The structure and governance of an LLC taxed as a partnership can appear more credible to investors and lenders, which may be beneficial if you’re seeking additional capital or credit.

Steps to convert LLC to S-Corp

  1. Check eligibility: Ensure your business meets the IRS requirements for S Corp status, such as having no more than 100 shareholders and only one class of stock.
  2. Elect S-Corp status: You will need to file Form 2553, “Election by a Small Business Corporation,” with the IRS. Form 2553 will need to be signed by all shareholders, and then filed within two months and 15 days after the beginning of the tax year in which the election is to take effect.
  3. Amend operating agreement: Modify your LLC’s operating agreement to reflect the S-Corp election and any changes in governance or management structure.
  4. Issue stock certificates: If necessary, issue stock certificates to the shareholders, documenting their ownership interests in the S-Corp.
  5. Adjust payroll and accounting systems: Set up payroll to pay owners a reasonable salary and update your accounting systems to comply with S-Corp requirements.
  6. Inform state authorities: Notify your state’s tax and business regulatory authorities of the change in tax status, if required.
  7. Maintain compliance: Follow S-Corp compliance requirements, including holding regular board and shareholder meetings, maintaining meeting minutes, and filing annual reports.

Can I convert my LLC to an S-Corp myself?

Yes, you can go through the process of converting an LLC to S-Corp without the help of a professional. However, we don’t recommend it. As we mentioned earlier, it is essential to understand the legal and financial implications and ensure compliance with IRS and state regulations.

Consulting with a tax professional or legal advisor can help you navigate the process smoothly and maximize the benefits of your new business structure.
If you have any questions or need assistance with converting your LLC to an S-Corp, don’t hesitate to reach out to our team of experts.

Stay Updated

Sign up for our email list to stay updated on the latest tax news and financial planning advice.

This field is for validation purposes and should be left unchanged.