Converting an LLC to an S Corporation can offer tax benefits and a shift in liability structure, but the process requires careful consideration and specific steps. Dive in to understand the advantages, prerequisites, and step-by-step guide for a successful transition.
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As a small business owner, you may have chosen to form your business as a limited liability company (LLC) for flexibility and tax advantages. But as your company has grown, you may wonder: Is it time to convert from an LLC to an S corp? As your business reaches certain growth and profit milestones, there may be circumstances where an S corporation — usually called “S corp” (please see our What is an S Corp? page) for short — tax election is more advantageous. Read on to learn more about changing an LLC to an S corp and why it may be right for your business.
An S corp is not a business structure. Instead, it’s a tax election available to both LLCs and corporations. Depending on the economics of your business, converting your LLC to an S corp may save you a bundle on self-employment taxes.
While becoming an S corp is relatively straightforward, you must confirm that your LLC is eligible to elect S corp taxation for your business. The requirements include:
If your business meets these criteria, then you may be well on your way to increased tax savings. Be sure to confirm with your tax adviser or accountant whether you fully qualify.
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When you’re ready to undertake an LLC to S corp conversion, here are three simple steps to help ensure your success:
Most LLCs will meet the basic IRS requirements to be taxed as an S corp, which we outlined above. If your company meets all these requirements, you can apply to convert your LLC to an S corp and take the next step.
Tax entity classification elections need to be made by specific due dates. You’ll need to notify the IRS about your decision to switch from an LLC to an S corp no later than two months and 15 days after the start of the tax year when you want the election to take effect. Thus, if you decide that beginning January 1, 2023, your company will be taxed as an S corp, you must inform the IRS by March 15, 2023. To do so, you would complete and submit IRS Form 2553, Election by a Small Business Corporation. This lets the IRS know your decision to change from an LLC to an S corp.
Once you submit your completed four-page IRS Form 2553, you’re well on your way to letting the IRS know you want to be taxed as an S corp. However, you should be aware of two potentially tricky issues as you file your forms:
First, all LLC owners need to sign Form 2553 to consent to the S corp election. This can sometimes be difficult to coordinate, especially if you have a large number of owners.
Second, the IRS can take at least six to eight weeks to process your election request.
When your business is growing quickly and profitably, self-employment and other taxes on your entire LLC pass-through membership share can become unwieldy. As your company grows and you have more members, more employees, and more profits, consider electing S corp status to save money and increase tax efficiency.
Businesses with S corp election have pass-through taxation, meaning that the company’s profits are only taxed at the individual owners’ level without first being taxed at the business level. Even though an LLC already has pass-through taxation by default, it could still benefit from electing S corp status. It takes a bit of explanation, but it could mean saving thousands of dollars.
The members of a standard LLC are considered self-employed. They’re compensated by receiving their share of profits from the LLC, but they can’t be employed by the LLC. Being self-employed means paying self-employment taxes (about 15.3%) on all profits they receive from the LLC. Self-employment taxes are the portion of taxes earmarked for Medicare and Social Security. This is more than the taxes they’d pay when working for someone else because their employer would pay half of them.
When the members elect S corp status, though, they can be compensated in two ways, by receiving their share of the profits and by being paid as an employee. Once they do that, they only pay self-employment taxes on their salary and not the profits they receive. (Of course, this is only for self-employment taxes; LLC members still must pay income and other applicable taxes on their profits.) This can add up to quite a lot for certain profitable LLCs.
One caveat to this is that the IRS expects you to pay yourself a “reasonable salary” as an employee of the LLC. Otherwise, you could pay yourself an annual salary of $1 and avoid contributing anything to Social Security and Medicare. The IRS considers “reasonable” to be something similar to what others in your field are earning.
Electing to be taxed as an S corp won’t impact the personal liability protection and management flexibility of an LLC.
You may want to consider converting from an LLC to an S corp when your profits exceed the amount you expect to pay in owner salaries. Depending on your specific tax circumstances, you should discuss the change from LLC to S corp with your tax advisor or accountant.
The biggest benefit of changing your LLC to S corp tax status is lowering the self-employment tax for members. As owner-employees, these individuals will need to be paid a reasonable salary, which will be subject to employment taxes. However, the remaining company profits will be taxed as income on the members’ personal tax returns.
Most S corp employees can save additional tax by having their S corp pay for their family health insurance coverage. If the insurance benefit is included as part of their wages and their family members are not covered under any other subsidized plan, this can help save a bundle.
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Our LLC formation service is an excellent resource to get entrepreneurs up and running quickly. Our full suite of renowned business compliance services and tools support you throughout the life of your LLC to not only help you get started, but to help your business grow and thrive. If you work with us to form your LLC, we can help you make your S corp election, making the paperwork a snap. Let us take care of formation, tax elections, compliance, and more, so you can focus on what you love to do.
Disclaimer: The content on this page is for information purposes only and does not constitute legal, tax, or accounting advice. If you have specific questions about any of these topics, seek the counsel of a licensed professional.
You don’t have to change to a different entity type before electing S corp status. S corps aren’t technically “corporations.” S corp status is a tax election. Put simply, you don’t need to change your entity type to a corporation before making the tax election.
An S corp can be an LLC. There’s a difference between an entity type and tax designation. An LLC is an entity type that can be designated for several different types of taxation. S corp taxation is a tax election that tells the IRS how you want your entity to be taxed.
An S corp is a tax election, while a C corp is the default form of corporation with certain tax designations and regulatory restrictions. Learn more about the differences in our S Corp vs C Corp guide.
An LLC has pass-through taxation by default, and an LLC with S corp election also has pass-through taxation. An LLC also has the option to be taxed as a C corporation, which would mean that the profits are taxed at both the business and individual levels. However, some LLCs elect C corp taxation because it has the widest range of deductions.
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