When do you move from an LLC to an S- Corp?

Share this post LinkedIn     Twitter     Instagram     Facebook    
22 May 2023

When do you move from an LLC to an S- Corp?

LLC vs. S-Corporation

A Limited Liability Company (LLC) and an S-Corporation (S-Corp) are two common business structures that offer their owners legal protection and tax advantages. An LLC is a flexible entity that combines elements of a corporation and a partnership. It provides its owners, known as members, with limited liability protection, meaning their assets are generally shielded from business liabilities. LLCs also offer pass-through taxation, where profits and losses flow to the members’ tax returns. Sounds good, right? LLC partnerships in the U.S. have declined for the first time since 1993 by 4.7%.  

An S-Corp is a type of corporation that allows for similar liability protection but offers potential tax advantages. S-Corps also follow the pass-through taxation model, but they allow for the distribution of profits as dividends, which are exempt from self-employment taxes. Choosing between an LLC and an S-Corp depends on various factors, including taxation, self-employment taxes, ownership structure, and compliance requirements. 

5 Factors to Consider  

The decision to transition from an LLC (Limited Liability Company) to an S-Corporation (S-Corp) is complex and depends on various factors. You should always consult a qualified attorney and tax professional before making the decision to switch business structures. Here are some factors to discuss.  

  1. Taxation: LLCs are typically subject to “pass-through” taxation, where profits and losses are reported on the owner’s tax returns. S-Corps also offer pass-through taxation, but they provide potential tax advantages by allowing owners to pay themselves a reasonable salary (subject to payroll taxes) while distributing remaining profits as dividends, which are not subject to self-employment taxes. 
  2. Self-Employment Taxes: In an LLC, all business income is subject to self-employment taxes, which include Social Security and Medicare taxes. S-Corps reduce these taxes by splitting income between salaries and dividends, only the former being subject to self-employment taxes. 
  3. Employment Benefits: S-Corps offer more flexibility in providing employee benefits, such as health insurance, retirement plans, and fringe benefits. These benefits may be deductible by the corporation, providing potential tax advantages. 
  4. Ownership and Investors: If you seek outside investors or issue different classes of stock, an S-Corp structure may be more suitable. LLCs have restrictions on the types of ownership interests they offer, while S-Corps have multiple classes of stock and easily facilitate investment opportunities. 
  5. Formalities and Compliance: S-Corps generally have more formalities and administrative requirements than LLCs. This includes holding regular shareholder and director meetings, maintaining corporate bylaws, and adhering to specific record-keeping and reporting obligations. 

It’s important to note that the decision to convert from an LLC to an S-Corp involves legal, tax, and financial considerations. Be sure you understand the ramifications in all three areas before making a change.  

The Right Time to Transition  

Determining the optimal time to transition from an LLC to an S-Corp depends on several factors specific to each business owner’s circumstances and goals. While there is no universally applicable timeframe, particular indicators suggest that a conversion could be beneficial. Typically, the decision to switch is motivated by tax considerations, such as the ability to reduce self-employment taxes and optimize distributions.  

Additionally, the need for outside investment, multiple classes of stock, and a more formal business structure influence the timing. To make an informed choice, it is crucial to consult with a qualified tax professional who can assess your situation and provide personalized guidance.