There are lots of options when it comes to selecting a business structure for your company. Deciding whether to remain an LLC or become an S corporation is an important decision that can have major implications for your company.
Understanding Business Types
Your LLC (limited liability company) is a structure you've selected under state law. However, because the IRS does not recognize LLCs, you must decide how your LLC will be taxed. If you choose to be taxed as a sole proprietorship or partnership, the LLC itself will not pay any taxes. Instead, taxes are passed through to the members, who report profit and loss on their own tax returns. Your LLC can also choose to be taxed as an S corporation, which means the LLC must file its own tax return and pay its own taxes.
It's important to understand that just because you might choose for your LLC to be taxed as an S corporation, it is not legally an S corporation. If you want to convert your LLC to an S corporation, there are specific steps you'll need to take.
Restrictions on Becoming an S Corporation
To become an S corporation, your LLC:
- Must be a domestic entity
- Can create only one class of stock in the corporation
- Must have fewer than 100 members who will be shareholders of the new corporation
- Cannot have shareholders who are partnerships, corporations, or nonresident aliens; individuals and some types of trusts and estates are permitted
- Must not be in a group of certain regulated businesses, such as certain financial institutions, insurance companies, or international sales corporations
To meet these requirements, you may find that you need to make some changes to the structure of your LLC and/or to your plans for the new corporation.
Steps to Change Your LLC to an S Corporation
To make the change, follow these steps:
1. Complete the form required by your state for statutory conversion of your LLC to an S corporation. You will pay a fee and receive a certificate of conversion.
2. If your state does not allow for statutory conversion, you need to do what is called a statutory merger, where your members swap their ownership for shares. You'll need to file the documents required by your state and pay fees. You may also need to dissolve your LLC.
3. Use IRS Form 2553, Election by a Small Business Corporation, to formally change your company's structure to an S corporation. If you want the election to be effective in the current tax year, you'll need to file it no more than two months and 15 days from the beginning of the tax year. If you miss the deadline, the election will become effective in the next tax year.
4. Use IRS Form 8832, Entity Classification Election, to choose your tax classification. You'll need to select S corporation if you had previously chosen to be taxed as a sole proprietor or partnership. If you have already elected for your LLC to be taxed as an S corporation, you do not need to refile this form. Note that if your LLC is a foreign entity, you cannot change it to an S corporation.
5. Have all current LLC members sign the election form.
6. File Form 1120S, U.S. Income Tax Return for an S Corporation, as your tax return for your LLC in the tax year in which the election occurs.
Effects of the Change
Once you elect to be taxed as an S corporation, your company will pay its own taxes and you won't be subject to self-employment tax. You will need to obtain a new Employer Identification Number (EIN) for your new S corporation. Moving forward, you will be a corporation, not an LLC, and so will file taxes as a corporation.