Updated on: February 23rd, 2024

How to Change an LLC to an S-Corp? A Beginner-Friendly Guide

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Converting your LLC to an S-Corp for tax purposes can be a complex process, yet it is totally attainable! You can submit the required documents to make this transition along with your income taxes. Doing so could provide you with several key benefits, such as reducing self-employment taxes and providing flexible salary options.

When you elect to be taxed as an S-Corp, the transition may not take effect until the following tax year. For this reason, it is essential that your current tax return accurately reflects such facts if applicable. Additionally, although filing with the IRS for treatment as an S-Corp alters your taxation status, it does not alter any other legal elements of your LLC business structure.

If you want to skip the hassle of starting an S-Corp yourself, consider using professional help from the best service providers in the market:

Pros and Cons of Changing an LLC to an S-Corp

All LLCs and small business owners should go through these pros and cons before deciding to convert their LLC to an S-corp.

Pros

Making a shift from an LLC to an S-Corp can provide significant advantages for small businesses.

  • Not only will self-employment taxes be reduced due to the corporation tax status, but this change can also provide businesses with more options when it comes to income tax purposes.
  • With the right setup, an S-corp may even allow businesses to avoid double taxation and offer owners the ability to deduct both business losses and health insurance costs on their personal income taxes.
  • Generally speaking, an S-corp structure offers greater asset protection and flexibility compared to that of the LLC structure.
  • Additionally, if there are more than one owner in the business, changing from an LLC to an S-Corp can also ensure more comprehensive organizational structures with respect to ownership rights.

As a result, switching from LLCs to S-Corps has become a popular option for small business owners looking for greater flexibility, improved asset protection, and a better-organized platform for handling finances.

Cons

When it comes to federal tax purposes, changing a limited liability company (LLC) to an S-corp may not be advantageous. Keep in mind that changing from an LLC structure to a corporation status is considered a liquidation and would bring about certain drawbacks.

  • For one, profits of the LLC will be taxed both as corporate income and shareholders dividends.
  • Moreover, assuming there are members in the LLC and they contribute property or services in exchange for membership interests, they would be liable for any gain that meets the requirements of Section 751 of the Internal Revenue Code when they distribute such profits as dividends instead of distributing them as earnings of members.

Ultimately, when making a decision to switch from an LLC to an S-corp status, you must assess your personal financial situations and determine if this change works best for you and your business.

Before You Change Your LLC Structure to an S-Corp

What Is an S-corp?

An S-corp is an advantageous tax election that both LLCs and corporations can adopt, as it may drastically reduce self-employment taxes based on the profits earned. This could be a game changer for your business – make sure to take advantage of this opportunity!

Consider Whether Changing To an S-Corp Is Advantageous For You & Your Business

Limited Liability Companies (LLCs) typically have ‘pass-through’ taxation, wherein any business profits and losses are passed directly to the owners or members of the LLC for personal tax purposes. Single-member LLCs would be treated as sole proprietorship in terms of taxation, whereas multiple-member LLCs will be taxed as partnerships. All members must also take into account self-employment taxes which include funds that support Medicare and Social Security programs.

LLCs, even single-member ones, can decide to be taxed as S-corps, which offers the same personal liability protection and management flexibility of an LLC. With this taxation method in place, owners get the opportunity to become employees of their own company and will have a reasonable salary that is subject to payroll taxes. Simultaneously, however, additional business profits are only subjected to income taxes – not both!

Confirm Your Business Is Eligible to Operate as An S-Corp

If you want to elect S-corp taxation for your business, you must meet the necessary criteria:

  • Be a US firm with no more than 100 members and shareholders;
  • Have only one class of stock; and
  • Shareowners can consist of individuals plus certain trusts and estates.

However, partnerships, enterprises, or nonresident aliens are not allowed as shareholders.


Form 2553 & Eligibility Convert an LLC to S-Corporation

To make your LLC eligible for S-Corporation federal taxation, it is necessary to fill out and submit Form 2553 with the IRS. But don’t forget: you must complete this form by March 15th in order to convert the LLC by that year or within 75 days of opening if you are starting a new business. Making an election for tax purposes has never been simpler!

Don’t miss the deadline! If you do, though, you may request late election relief from the IRS if there is a valid excuse. Just keep in mind that with this option, your company’s entity type remains unchanged—the federal tax classification merely shifts. And even though the LLC is classified as an S-Corp by the IRS, it still must be taxed like an LLC according to the state laws where it was formed.

To restructure your LLC to a Corporation, you must first complete the formal conversion process mandated by your formation state. While some states have an established procedure in place, others may require certain alternative methods.

File IRS Form 2553

If you are converting your LLC to an S-Corp, make sure you file IRS Form 2553. To ensure the tax election is effective for the full year, you must submit this form prior to March 15th of that same year or during any time in the previous year. Additionally, if your LLC was just established and has yet to launch operations, simply file Form 2553 within 75 days following formation and everything will be taxed as an S-Corp from then on!


How to Convert Business Formation from An LLC to An S-Corp

You don’t have to become a corporation in order to select the S-Corp tax classification. Yet, if your yearly profits tend to be quite considerable or carry over from one year into another, you might consider changing your LLC into an official C-corporation (C-Corp), instead of opting for being taxed as an S Corporation.

If you’re looking to transition your LLC into a corporation for management and formation purposes, it’s vital that you officially change the business with the secretary of state in your state. Get in contact with them so you know precisely what requirements as well as fees are necessary before committing.

How Does an S-Corp Differs From a C-Corp?

The bottom line is taxes. By default, a C-corp organization incurs double taxation: first at the business level, and then again when profits are paid out to the owner(s) as dividends or distributions. On the other hand, an S-corp only gets significant tax exposure once income reaches the owners’ individual returns through these same distribution methods.

How To Know If S-Corp Tax Election Is Right for You

If your LLC is able to pay a reasonable salary and distribute annual profits among its members, electing S-corp tax status could be beneficial. To ensure that you make the right decision for your business, it’s best to consult with an experienced tax advisor before making any changes.


When Is The Right Time To Convert Your LLC To S-Corp?

For tax purposes, it’s smart to consider converting an LLC into an S-Corp when the self-employment taxes exceed what your S-Corp would pay. Usually, if you have $40k in net income or more annually, changing over is worth considering – even at lower earnings like $25k per year.

The specifics of this situation depend upon multiple numbers of factors, such as:

Salary Amount

S-Corp owners may receive a salary out of the profits. It can be tough to provide an exact dollar figure since it depends on both the industry and net income. On that note, you might come across guidance stating salaries should take up two thirds of net income; however, this is not absolute so it’s best taken with caution. The ideal wage amount must reflect market trends and be justifiable when warranted.


Foreign Earned Income Exclusion (FEIE)

For business owners who qualify for the Foreign Earned Income Exclusion, income tax can be excluded up to a maximum of $107,600 (2020).


State

In many states, including California and New York, taxation at the S-Corp level as well as the individual shareholder level occurs. What’s more, in New York even if an individual does not live there they are still taxed by the S-Corp on their behalf. While this reduces potential tax savings from switching from LLC to S Corp within those states, it is often still beneficial for conversion due to retirement savings options attainable through that change.


Should I Convert from LLC to S-Corp or Not?

The decision to convert from an LLC, partnership, or sole proprietorship to an S-Corp should only be made when your business profits exceed the amount you’d sensibly pay yourself in salaries. Analyzing tax effects that apply to your individual circumstances might become complex and thus it is best advised to consult a certified accountant or tax advisor on this matter.


Get Professional Help in Forming an S Corp Today

It can be difficult and time-consuming to form an S-Corp all by yourself.
That’s why we decided to give you a few of the best options for professional services that can help you start an S-corp in no time & with 0 effort!

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To know more about them — read our ZenBusiness review here.

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