A Guide to Changing an LLC to an S-Corp
A Guide to Changing an LLC to an S-Corp
Most small business owners begin the start-up as LLCs due to ease of formation, tax advantages, and legal liability shield. However, if businesses expand and generate more revenues and profits, it is wise to change to S-Corp to reduce taxes. In this guide, let us learn what an S-Corp is, why you should change, and how to do it.
What Is an S-Corp and Why Switch?
S-Corp is not another form of business structure like LLC or Corporation but it is a special tax status for the entities that fall into either of the types. In case your LLC’s profits are higher, switching to an S-Corp will prove beneficial when it comes to taxes.
LLCs file taxes in the same way partnerships do, also known as pass-through taxation because the income is taxed on the owners’ tax returns. Of them, they also contribute to the Self Employment Taxes that provide for Social Security and Medicare. To learn how you can minimize self-employment taxes to only the owner’s salaries with anything beyond that taxed as income—potentially saving you thousands in payroll taxes—continue reading.
How to Know If S-Corp Tax Election Is Right for You
Whether or not you should convert your LLC to an S-Corp is determined by your profits. If your business generates enough cash flow to pay a reasonable wage to the owners and still have some cash flow left, then forming an S-Corporation may be the best thing to do.
S-Corp owners must pay themselves a “reasonable” wage in which they will still have to pay payroll taxes; however, other profits are excluded from such taxes. That simplicity is as the business progresses the tax benefits from this can be very huge.
However, converting to an S-Corp does make your taxes a bit more complicated. You have to provide more documents and follow the requirements of the IRS. For instance, your business should be located in the United States; the company should have no more than 100 shareholders; and there should be no more than one type of share issued.
Steps to Change From an LLC to an S-Corp
Converting your LLC to an S-Corp is relatively straightforward:
File IRS Form 2553: To make the switch, a company will have to submit Form 2553 called ‘Election by a Small Business Corporation’ to the Internal Revenue Service. If the applicant wishes the S-Corp status to be implemented for the current fiscal year, the form needs to be submitted by March 15th. If you have just formed your LLC, then you have 75 days from the formation date to file that form for that tax year.
Ensure Eligibility: Before changing your status, however, ensure that your business is eligible under the IRS requirements. Your business must be a domestic U.S. company and you may not have more than one hundred shareholders. You need to have all shareholders being individuals (or certain trusts and estates) and you can issue only one class of stock.
Maintain Proper Records: If you’re an LLC that’s been taxed as an S-Corporation, you have to maintain precise records of your business’s income and expenses, including wages paid to owners and distributions made to them. You will also need to adhere to the corporate formalities such as holding annual shareholders meetings together with the preparation of meeting minutes.
S-Corp vs. C-Corp: What’s the Difference?
The main distinctive feature of the S-Corp and C-Corp business structures refers to the taxation of profit. S-Corporations report the profits on their tax return and then the owners report them on their own tax return. There’s no corporate tax. In a C-Corp, profits are taxed twice: This is done before issuing to the users when it is still at the corporate level and the second time when it has been distributed as a dividend. This is one of the reasons why many small businesses prefer to register as an S-Corp to avoid this “double taxation”.
Conclusion: Is Changing to an S-Corp Right for You?
While converting from LLC to S-Corp is a good idea for numerous reasons, the main benefit is in terms of taxes, particularly for businesses that make good amounts of money. However, it comes with some administrative burdens; therefore, one should seek advice from a tax consultant before embarking on the process. When you choose S-Corp status, you will retain all the advantages of an LLC, including personal asset protection and the ability to remain unincorporated, as well as potential tax breaks that could benefit your company.