How to Change an LLC to an S-Corp

If you have a limited liability company (LLC), you may have heard that an S-Corp is a better structure in terms of financing. In many cases, this is true – but how do you change from an LLC to an S-Corp? 

It sounds like it might be complicated, but it’s relatively simple. This guide walks you through the process. 

What Is an S-Corp?

An S-Corporation is not a business entity type but a business’s tax classification. It is a corporation or LLC that can be taxed as an S-Corp by meeting specific IRS requirements. 

With S-Corp status, income passes through the business to shareholders or owners without that income being taxed as corporate income, just as in an LLC. However, in a regular corporation, also known as a C-Corp, the corporation is taxed, and the dividends shareholders receive, sometimes referred to as double taxation.

Corporations and LLCs can be classified as S-Corp if they have 100 or fewer shareholders or members. In addition, S-Corp shareholders can only be individuals or specific types of trusts, estates, or tax-exempt organizations.

How LLCs Are Taxed

LLCs are pass-through entities, meaning income passes through to the member or members who report the income. The LLC itself is not taxed. If the LLC has only one member, it’s taxed as a sole proprietorship. If the LLC has more than one member, it’s taxed as a partnership. 

However, LLCs are unique because they can elect to be taxed as a corporation if the members decide it makes financial sense. This is done by filing an election form with the IRS. In addition, you can choose to be taxed as a C-Corp or an S-Corp.

C-Corp status means income is taxed at the current rate for corporations (21% as of late 2022), which is lower than the usual individual taxpayer rate. But keep in mind that C-Corp shareholders – who are members in the case of an LLC – must also pay taxes on their distributions. 

However, members are subject to self-employment tax in an LLC that is taxed by default as a sole proprietorship or partnership. Once such LLC switches to being taxed as a corporation, self-employment taxes no longer apply. 

Similarly, self-employment taxes do not apply to members with S-Corp status, which is the main advantage of electing S-Corp status. LLCs with S-Corp status are still pass-through entities. The LLC itself is still not taxed. 

With S-Corp status, members are generally paid as company employees, which means more accounting and payroll expenses. Therefore, S-Corp status is only beneficial when the self-employment tax savings exceed those additional expenses. 

How to Elect S-Corp Status

To elect S-Corp status for your LLC, you simply need to file Form 2553 with the IRS. You’ll designate a tax year on the form, beginning with a specific month, day, and year. You must complete and file this form:

• No more than two months and 15 days after the beginning of the tax year in which the election is to take effect, or
• Any time during the tax year before the tax year in which the election takes effect 

What Else Changes When I Elect S-Corp Status?

You must know a few things that change when you elect S-Corp status.

Ownership

An LLC can have unlimited members, including U.S. citizens, non-U.S. citizens, non-U.S. residents, or another corporate entity.

S-Corps, however, cannot have more than 100 shareholders or owners, and those shareholders cannot be non-U.S. citizens or non-residents, nor can they be another corporate entity.

Management

LLC members have complete control of the company and can structure their management in any way they choose. However, when an LLC elects S-Corp status, it must appoint a board of directors, hold annual meetings, and keep minutes of those meetings for its records.

S-Corps also must appoint corporate officers such as a Chief Executive Officer (CEO) and a Chief Financial Officer (CFO).