How To Change an LLC To an S Corp

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As a business owner with a limited liability company (LLC), you may have started with this structure for its simplicity and flexibility. However, as your company grows and becomes more profitable, changing to an S corporation (S corp) could provide significant tax advantages. 

In this blog post, we’ll explore the reasons why you might want to make this change and provide a step-by-step guide on how to change your LLC to an S corp. If reducing your tax burden and positioning your business for further growth sound appealing, keep reading.

Why Change an LLC to an S Corp?

The primary motivation for changing from an LLC to an S corp is the potential for self-employment tax savings. Here’s how it works:

Avoiding Self-Employment Taxes

In an LLC, all profits are subject to self-employment taxes (15.3% for Social Security and Medicare) in addition to income taxes. With an S corp, only the salaries paid to shareholder-employees are subject to self-employment taxes. 

Any additional profits distributed as dividends are exempt from self-employment taxes, resulting in substantial savings for profitable businesses.

Raising Capital and Attracting Investors 

S corps can have up to 100 shareholders and issue stock, making it easier to raise capital and bring on investors compared to an LLC. This increased ability to attract funding can fuel growth and expansion plans.

Perpetual Existence 

Unlike LLCs, which can be dissolved upon the withdrawal or death of a member, S corps have a perpetual existence independent of their ownership structure.

Eligibility Requirements for S Corp Status

Before converting, ensure your LLC meets the following criteria to qualify as an S corp:

  • Be a domestic corporation
  • Have no more than 100 shareholders
  • Have only one class of stock
  • Have shareholders that are individuals, certain trusts, or estates (not partnerships or corporations)
  • Not be an ineligible corporation (e.g., financial institutions, insurance companies)

Step-by-Step Guide: Changing an LLC to an S Corp

Step 1: Check State Laws for Conversion Process

Each state has specific requirements for changing an LLC to a corporation. Some states allow for a statutory conversion, while others may require more complex steps like statutory mergers or forming a new corporation.

Step 2: File Articles of Conversion/Incorporation 

Following your state’s procedures, file the necessary paperwork (e.g., articles of conversion, and articles of incorporation) to convert your LLC into a corporation.

Step 3: Elect S Corp Status with the IRS 

After incorporating, file Form 2553 (Election by a Small Business Corporation) with the IRS to elect S corp taxation status. This form must be filed within a specific timeframe, typically within 75 days of the incorporation date or by the 15th day of the third month of the tax year.

Step 4: Update Corporate Records and Comply with Formalities 

As an S corp, you’ll need to maintain corporate records, hold annual shareholder and board meetings, and follow other formalities. Ensure your bylaws, stock certificates, and other documents reflect your new corporate structure.

Step 5: Obtain a New Employer Identification Number (EIN) 

You may need to apply for a new EIN with the IRS after converting to an S corp.

Step 6: Consult with Tax and Legal Professionals 

Due to the complexities involved, it’s highly recommended to work with tax advisors and lawyers experienced in business entity conversions to ensure compliance with all federal, state, and local regulations.

Potential Drawbacks of Converting to an S Corp

While the tax savings can be significant, there are a few potential downsides to consider:

  • Increased Formalities and Paperwork: S corps have more stringent reporting and recordkeeping requirements compared to LLCs.
  • Reasonable Salary Requirements: The IRS closely monitors S corps to ensure shareholder-employees are paid reasonable salaries, not just dividends to avoid payroll taxes.
  • Ownership Restrictions: S corps are limited to 100 shareholders and cannot have non-resident alien owners.

The Bottom Line

Converting your LLC to an S corp can be a strategic move for businesses with substantial profits, growth plans, and a desire for tax optimization. 

However, it’s crucial to carefully evaluate your specific circumstances, eligibility, and potential drawbacks before making the transition. Consult with professionals to ensure a smooth conversion process and continued compliance with all relevant regulations.

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