It is possible to change a limited liability company (LLC) to a corporation, and it’s a simple process in many states. But if you only want to become a corporation for its tax advantages, you can also remain an LLC and elect to be to be taxed as an S corporation.
LLCs vs. Corporations
LLCs and corporations are types of business entities. “S corporation” and “C corporation” refer to the way a corporation is classified for income tax purposes.
Both LLCs and corporations limit their owners’ personal liability for business obligations, but they differ in their ownership and management structure in the following ways:
- Corporations have a standard management structure that includes a board of directors and officers. LLCs can be managed in any way the owners choose.
- Corporations generally have more recordkeeping and reporting requirements than LLCs, and they’re required to hold annual shareholders’ meetings.
- Corporate shares are easy to transfer from one owner to another, making corporations popular with outside investors. An LLC’s membership interests are more difficult to transfer.
Why Change from LLC to S Corporation Taxation?
LLCs are unique in that they don’t have their own federal income tax classification. Instead, the Internal Revenue Service automatically taxes LLCs as “disregarded entities,” meaning that single member LLCs are taxed like sole proprietorships and multi-member LLCs are taxed like partnerships.
An LLC can, however, choose to be classified as an association taxed as a C corporation or an S corporation.
A Disregarded Entity
If an LLC is a disregarded entity, its income and expenses pass through to the owners’ personal tax returns, and the owners pay personal income tax on any profits.
Owners of disregarded entity LLCs are considered self-employed individuals. This means that they must pay Social Security tax up to the annual maximum, and Medicare tax on the full amount of the LLC’s profits.
An S corporation also provides pass-through taxation. In contrast, a C corporation pays corporate income tax and the shareholders then pay personal income tax on their distributions.
S corporation shareholders who also work in the business are considered employees of the corporation. They must pay themselves a reasonable salary and they must pay Social Security and Medicare taxes on that salary.
By electing S corporation status, an LLC owner can save on self-employment taxes if the owner’s share of the business profits is greater than the amount the owner would reasonably earn as salary. Corporations may also be able to take additional tax deductions, such as a deduction for owner-employee’s health insurance plans
How to Convert LLC to S Corporation
If you believe your business structure should be changed from LLC to corporation, the LLC to S corporation process requires two steps: converting your LLC to a corporation and then electing S corporation status with the IRS.
The first step in an LLC to S corp. conversion is to determine whether your LLC qualifies for S corp. status. Not all corporations can be taxed as S corporations. The requirements include:
- Must be a domestic corporation
- Must have no more than 100 shareholders
- None of the shareholders can be a partnership, a corporation or a nonresident alien
- There can only be one class of stock
If your LLC meets the S corporation requirements, then in many states you can use a process known as a “statutory conversion” to make the LLC/S corp. change.
In a statutory conversion, the LLC’s assets and liabilities automatically transfer into a corporation. There’s no need to form a new corporation and dissolve the LLC.
The statutory conversion process is relatively simple: you file a certificate of conversion and other required documents with the state and pay a filing fee. Information, forms and filing fees are typically available on the website of your state’s business filing agency.
If your LLC was formed in a state that doesn’t allow statutory conversions, you will probably have to undertake a more complicated change procedure known as a statutory merger. In a statutory merger, you form a corporation with your LLC’s members as shareholders.
The shareholders then approve a plan of merger and swap their membership interests in the LLC for shares in the corporation.
To complete the statutory merger, you must file a certificate of merger and any other required documents with your state. You may also be required to file documents formally dissolving the LLC. A statutory merger can be complicated, so it’s a good idea to seek advice from a small business attorney.
Once you have completed the process of converting the LLC to a corporation, you must file Form 2553, Election by a Small Business Corporation, with the IRS to elect S corporation tax status.
How Can an LLC Be an S Corporation for Tax Purposes Only?
To be taxed as an S corporation while still being organized as an LLC, an LLC must meet the same requirements as a corporation regarding number and type of owners.
The LLC must then file IRS Form 8832, Entity Classification Election. Once that is done, the LLC can elect LLC as S corp. taxation by filing Form 2553, Election by a Small Business Corporation.
Taking advantage of S corporation taxation for your LLC is as simple as filing forms with the IRS. To change your entity from an LLC to a corporation, you’ll also need to file forms with the state, and in some states you may have to undertake a more complicated statutory merger.