Converting LLC to S-Corp: Requirements and Benefits

Changing Tax Filing to an S-Corp

Purpose

Converting LLC to S-Corp taxation can be a strategic move for business owners, but it involves several considerations. Here’s a breakdown of the key aspects:

Summary

Typically, the main reason to switch taxation to an S-Corp taxation is tax savings, as the typical tax savings can be 8-15%. However, with the change also comes some negatives. The positives and negatives should be carefully considered before making the switch, as the business must stay an S-Corp for at least 5 years after the switch.

S-Corp Requirements

  • Must be a domestic corporation.
  • Limited to 100 shareholders.
  • All shareholders must be U.S. citizens or residents.
  • Only one class of stock is permitted.

Understanding the Structures

  • LLC (Limited Liability Company): By default, an LLC is a pass-through entity, meaning income is reported on the owners’ personal tax returns. Owners pay self-employment taxes on all profits.
  • S-Corp (S Corporation): Also a pass-through entity, but allows owners to take a salary and potentially reduce self-employment taxes. Only the salary is subject to self-employment taxes, while profits are taxed at the individual level.

Benefits of S-Corp Taxation

  • Self-Employment Tax Savings: Income from an S-Corp is not subject to self-employment tax.
  • Distributions: Owners can classify part of their income as distributions, which allows the owners to take tax free money out of the business.
  • Owner’s Personal Loans: S-Corp owners can pay their owners via payroll, which creates paystubs and w2s, which may allow the owner to obtain a higher loan, such as a mortgage.

Negatives of converting LLC to S-Corp Taxation

  • Extra Tax Return: An S-Corp has its own separate tax return, which typically comes at an extra cost.
  • Extra Payroll Costs: S-Corp Owners are required to issue themselves a paycheck. A payroll software is highly recommended for this, which comes at an additional cost.

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