Should You Convert Your
Single Member LLC to an S corp?
The LLC taxed as S corporation – good idea or bad?
By default, a single-member LLC is classified for tax purposes as a “disregarded” entity, that is, the entity is ignored by the IRS and the sole member is the taxpayer. Thus, an individual as a sole member running a business would be taxed on his personal return as a schedule C, sole proprietor. Â Many businesses run this way, which has no tax advantages and high risk of audit.
Most tax professionals would recommend running an operating business (especially with employees) as an S corporation rather than as a sole proprietor.  This is mainly to reduce the amount the corporation’s owner pays in self-employment (FICA) tax.  A secondary reason is that a small business S corporation has a lower risk of an audit than a schedule C sole proprietor business.
But, what if you already formed an LLC? Â No worry, you can convert the LLC for federal income tax purposes to an S corporation. This involves several steps:
- Get a federal tax ID# from the IRS.
- File IRS form 8832 to choose an entity election as a corporation
- File an S corporation election form (IRS form 2553)
- Amend your operating agreement to allow for the new taxation rules (or, if you don’t have one at all, CREATE an operating agreement).
The LLC tax as an S corporation may require the assistance of a tax advisor and/or attorney to complete, depending on how comfortable you are with the forms and documentation. Â A “generic” operating agreement used for a typical LLC is not appropriate because it does not address the specific provisions of the tax code dealing with S corporate taxation. Â Thus, you need something more tailored to deal with an LLC taxed as an S corporation.
The next issue is whether the LLC taxed as S corporation must ACT like a corporation for tax purposes even though the state LLC laws may not require it? For example, do you need to issue stock certificates, have annual meetings and resolutions like a corporation. Â In theory, no, because state LLC laws in most states do not require these formalities. Â In fact, most state LLC statutes say that failure to have ANY formalities (such as an operating agreement or minutes) is NOT by itself a reason for a court to “pierce the corporate veil” (hold the member liable personally for LLC debts).
While still a rather new concept, the LLC taxed as S corporation can be a feasible proposition for someone who formed a single member LLC and should have really created an S corporation.
Note that the LLC taxed as S corporation is better for businesses with ordinary income that would normally be subject to self-employment tax on a schedule C. Â For passive income such as rental income, the LLC taxed as a partnership (requiring more than one member) is usually recommended.
Kit: Convert LLC to S Corporation! |
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