Remember back when you had to decide on a name to register your new business, forming a limited liability company—LLC? Now your small business has grown up thanks to your hard work and dedication. You may have outgrown your current legal status and it’s time to change from an LLC to S Corp to gain additional tax benefits that you’ve earned! Since determining the status of your business is important to its success and potential, we’ll break it down for you.
What is an S Corporation?
Under “S” corporation status, the small business owner’s income, losses, deductions, and credits “flow through” to you and are reported on your personal tax returns and assessed at your individual income tax rate. S Corp status is great for small businesses because you have the LLC protection from losses beyond your capital investments, while still providing you with the flow-through taxation.
How is an LLC Different from an S Corporation?
As an LLC owner, you could lose everything you have invested in the business, but your personal home, bank account, and other assets are protected. The main differences between an LLC and an S Corp are:
- An S Corporation isn’t a business entity like an LLC—it’s an elected tax status.
- LLC owners must pay self-employment taxes for all income. S corp owners may pay less on this tax, provided they pay themselves a “reasonable salary.”
- LLCs can have an unlimited number of members, while S Corps are limited to 100 shareholders.
Why you should consider changing from an LLC to an S Corp
Here are three great reasons to change from an LLC to an S Corp:
S Corp distributions aren’t subject to FICA/self-employment taxes. This is one strategic way to minimize self-employment taxes, making it a great business structure for consultants, sole-proprietors, and more. If you have an S-Corporation and are active in the business, you must pay yourself a market-rate salary for your work The IRS won’t let you pay yourself entirely in distributions to avoid self-employment tax.
Tax-preferred retirement savings
You can contribute more to retirement accounts with an S Corp than an LLC because with an S Corp you can set up a Solo 401(k) in addition to a Roth IRA.
Easier to scale
S Corps allows for a smoother transition from a C Corp. Stockholders are required to report their percentage of the profit/loss whether or not they actually receive that money as a distribution. If you own 100 percent of an S Corp and it makes X dollars in profit, you can keep that money in the business to make purchases next year. You are still required to report the profit on your individual tax return. If you anticipate keeping a significant amount of money in the business, you may be better off as a C Corporation.
How do I change from an LLC to an S Corporation?
If you decide to change from an LLC to an S Corp for federal tax purposes, you can simply make an election for the LLC to be taxed as an S Corporation. All you need to do is fill out a form and send it to the IRS. Once the LLC is classified for federal tax purposes as a Corporation, it can file Form 2553 to be taxed as an S Corporation.
With this approach, you don’t change the actual entity type, only the federal tax classification. Even though the IRS classifies the LLC as S Corp, it is still an LLC and may be taxed as such by the state where it is formed.
To change the actual entity structure you must formally change the LLC to an S Corporation with the formation state. If the simple conversion process is not allowed by the formation state, then you can do the following:
- send the IRS a letter informing them of the structural change
- choose to be an S Corporation by filling out IRS Form 2553
- cancel the LLC while filing with the state for a new corporation
Is Switching from LLC to an S corp right for my business?
When you’re ready to change from an LLC to S Corp, we recommend that you consult an accountant or tax preparation services to make sure there are no mistakes that could cause you to lose your money-saving tax status. Your Xendoo team of small business accounting experts can help you find the right solutions for your small business, and take the hassles of tax prep and filing off your shoulders. Whether it’s the 1120S, 1120, or 1065, Xendoo’s CPAs will file the right return for you, right on time.
With bookkeeping, tax consulting, and tax filing all under one roof, your U.S.-based Xendoo financial team is here to answer all your questions and to file your business and personal taxes. We’ll do what we do best — and let you get back to doing what you do best to make your business a success. Sign up today.