Whenever you are looking to grow your business in an effective way, it’s important to remember tax classifications and business designations.
There are implications that come with the territory, whether you decide to create a Sole Proprietorship, General Partnership (GP), Limited Liability Company (LLC) or S Corp.
If you’re kicking around the idea to change LLC to S Corp, look no further than the information below.
Limited Liability Company (LLC) and S Corp: The Ins and the Outs
First things first, you should get to know these different business types and what they entail.
A Limited Liability Company (LLC) is a company in which multiple members own and participate in the entity. This is usually the most straight forward way to form a company, and one of the first that people decide on.
An S Corp is a type of company that doesn’t pay tax but instead passes its profits and losses along to investors known as shareholders.
Going from a sole proprietorship to a Limited Liability Company (LLC) is usually the first step that most business owners make. However, from there, a number of business owners make yet another leap by incorporating in the form of an S Corp entity.
It’s important to understand what prompts companies to make this switch.
Why You Might Switch to an S Corp
You probably know that corporations are beholden to different tax rules and financial implications than other entities.
Switching to an S Corp is a matter of preference, and there are a number of reasons that people decide to do it. Here are the main reasons that you might want to go the S Corp route:
1. Added Asset Protection
Operating as an S Corp brings with it a host of benefits — such as additional asset protection.
When you create an S Corp entity, you are limited liabilities not just for yourself, but also for your shareholders. Each person that invests won’t hold any personal liability, which could make it an attractive option.
You can also change over ownership in a fairly straightforward manner, making it a great low maintenance option.
2. More Dividend and Salary Options
There are also a number of dividend options you can reap the rewards of whenever you choose to classify as an S Corp.
This is an attractive option because you are able to pay yourself and others on payroll a salary. What’s more, you can still get paid dividends that come about whenever your S Corp is profitable.
3. A Host of Tax Benefits
Understanding the way you are taxed is a huge part of restructuring any business.
S Corps are favorable from a taxation standpoint because you can set it up in any way that is advantageous. For instance, depending on your salary and circumstances, it might be more advantageous to simply stay on as an owner that receives dividends, or you might find better success taking on a salary as a paid employee.
You can tailor it in whatever way is the most beneficial to your company and to you as a professional.
4. Cleaner Accounting Methods
When you switch to an S Corp, there are a number of perks you will enjoy when it comes to your accounting methods as well. In most cases, the accounting process is more straightforward and allows for cleaner records.
You’ll find the process easier, from handling your tax forms to maintaining a cash accounting method.
5. You Won’t Have to Pay Self-Employment
Perhaps one of the biggest advantages is that you don’t have self-employment tax when you create an S Corp.
Since you are working for the entity and not as a sole proprietor, it is not technically considered self-employment. As such, you’ll get to hold onto more of your money when tax time rolls around, and perhaps even get a refund.
How to Change LLC to S Corp
1. Understand Exactly Why You Are Making the Switch
First, get to know the “why” involved with changing to an S Corp. While the benefits above are clear, the last thing you’ll want is to arbitrarily make a decision.
Consider how these changes will make a difference in your business specifically, and whether or not it is worth pursuing.
There are some key situations in which you’ll probably know that it is time to make the change to an S Corp.
For one, you’ll need to make that change once you are ready to drum up business capital by seeking investors. Since it’s so straightforward to purchase and sell shares through a corporation, this makes it a lot more favorable for the people that want to get involved.
Also, if you’re ever planning to distribute stocks you’ll definitely need to make your business into a corporation. People also decide to go the S Corp route when they are advised to do so for tax reasons.
Get to know your specific reason and make sure you are fully aware of what it means long-term.
2. Research the Implications That Come With the Territory
No matter what, there will be some implications that you’ll need to embrace once you decide to make the change to an S Corp.
For one, you will need to uphold some mandatory obligations on how you report information in your business. All corporations are bound to these sorts of reporting obligations, while LLCs and other entities are not.
3. Make Sure You’re Qualified
There are certain prerequisites you need to be aware of when switching to S Corp.
Before your application can be approved, your company must have less than 100 shareholders, and can’t have more than one class of stock.
It’s possible that you might have to register a Fictitious Name (DBA) for your S Corp entity. Touch base with the taxing authority where you live and apply for permits that apply.
4. Consult With a Financial Professional
Before taking any steps to change your business, hire the help of a financial advisor.
Research the different kinds of advisors and get references from other professionals you trust. Some of the specialties that your financial advisor might have include investment, financial planning or commercial accounting.
An advisor will walk you through the steps of applying for an S Corp and will explain in detail how this change will affect your accounting practices, company personnel, taxation, and other matters.
A financial advisor might typically charge you between approximately $100 per hour and $300 per hour. Get your financial advisor’s fee structure in writing before getting service.
The investment of hiring a financial advisor before filing as an S Corp will pay for itself.
5. Get Your Hands on the Right Paperwork
Now that you’re ready to file as an S Corp, you’ll need to get the correct forms. Filling out your information correctly the first time will help you expedite the process so that you don’t hit snags along the way.
The paperwork you will need includes IRS Form 8832 and IRS Form 2253. You will also need to put together a letter of your own to the Internal Revenue Service (IRS) declaring your intent to change the classification of your business.
It is in this letter that you can explain your plans for the change and which steps you will take. Be sure to include any previous business license numbers and dates with the letter.
IRS Form 8832 is an entity classification form intended file for a small business corporation. It lets you select a tax class outside of your default one.
IRS Form 2253 is a similar form that specifically allows you to file as an S Corp. You will also need to file a statement with the IRS that cancels your Limited Liability Company.
Fill out both of these forms thoroughly, and choose the correct boxes for the tax classification you intend to accept. The timetable for these forms is important and will dictate how your business will be treated for the remainder of the tax year.
The deadline each year is two months and 15 days from the first day of the year. In general, you can expect this timeline to fall on March 15.
Make sure that you complete all of your paperwork well before the deadline so you know it is filled out correctly and accurately without having to rush.
If you do happen to miss the deadline for whatever reason, you can still reach out to the IRS expressing your intent. They can make exceptions on the deadline upon request, as long as you pass certain conditions.
For these situations, you would benefit from having the help of a business attorney.
6. Restructure Your Company Accordingly and Consult an Attorney
Touch base with a business attorney that specializes in taxation. They’ll help you make sure that your re-classification process goes through smoothly, and can help you out in the event that you do need to request an exception to the deadline.
These business lawyers might charge you a flat fee or an hourly rate, so shop for the best attorney and make sure you are fully aware of what you are paying.
After you have filed as an S Corp, there are a number of steps that you will need to take. In some states, you’re required by law to publish an announcement about the formation of your new S Corp with the local newspaper. These letters are dated within the first month of this change and will be published in the Business Announcements section in print and online.
You will also need to check in with your state’s Franchise Tax Board, which will likely charge you taxes of their own.
It’s also important to communicate with your new shareholders and issue them all of their official shares and documentation. Start planning your first shareholder’s meeting, and be sure to allot time to explain the mission statement of your new company and what you intend to accomplish in the first year and the first 5 years.
Make sure you are as transparent as possible and always provide value to your shareholders.
You will need to also schedule a meeting to appoint your board of directors. Create bylaws for how decisions are made within the company and start optimizing the way your business is structured.
Now is the time to pinpoint those ready to step up and take leadership roles. When you have a solid network of communication throughout your company’s various roles and departments, you’ll establish a strong foundation for your new S Corp.
It might make sense to have your business attorney on retainer at this juncture since you will need ongoing advice and another set of eyes on contracts as you begin putting the wheels in motion.
7. Upgrade Your Company’s Organization and Planning
Invest in an enterprise resource planning (ERP) system that will optimize your communication infrastructure. You’ll be able to seamlessly store and update your business and legal documents on the fly.
This cloud-based software also creates access control and permissions, while keeping logs of every single change that happens. Strive to get organized and seek the assistance of an attorney every step of the way.
Make the Big Switch From LLC to S Corp
These tips are useful when you are trying to change LLC to S Corp.
Taking this leap requires some diligence and attention to detail, so do your research and stay aware of what this change entails. We would be happy to help you through every step of the process.
Fill out an online form to contact us today, or pick up the phone and call (855) 904-0180, 24 hours a day!