Switching from Sole Proprietorship to S Corporation
To switch from a sole proprietorship to an S corporation:
- Make sure you qualify.
- Form a corporation or LLC.
- Draft corporate bylaws and hold a board meeting.
- File Form 2553.
Advantages of an S Corporation
The main advantage of an S corporation over a sole proprietorship is that an S corporation does not pay a corporate-level income tax. An S corporation also protects business owners from personal liability.
Disadvantages and Requirements
However, there are some disadvantages to an S corporation, such as more complex recordkeeping and accounting requirements. You also need to file articles of incorporation and hold annual meetings.
Switching to S Corporation Timing
If you already use a digital bookkeeping program, you’ll create a new file. In general, you’ll want to consider electing S-corp tax status for your LLC if your business is generating sufficient profits to pay a reasonable salary to the members and annual distributions. You should review your specific situation with a tax advisor before making the switch.
Indicators for Switching to S Corporation
There are a few key indications that should cause a sole proprietor to consider S corp status. If at least two of the following points are of high interest to you, an S corp will probably be the way to go:
1) You want to protect your personal assets.
2) You want to draw a salary.
3) You want flexible ownership.
Converting LLC to S-Corp
If a company can pay its owners "fair wages" and at least $10,000 in dividends every tax year, then a multi-member LLC should choose the S corp classification.
Electing S-Corp Tax Status
Step 4: Elect to be taxed as an S-corp. Because making the transition to an S-corp from an LLC is a tax election rather than a legal entity change, you only need to use IRS Form 2553 to make the switch to an S-corporation.
Benefits of Switching to S-Corporation
The timing of the switch to an S-corporation is important. One of the key reasons why entrepreneurs choose to change an LLC to an S-Corp is the tax benefits that an S-Corporation offers:
1) Self-Employment Tax Savings
2) Ability to Deduct Health Insurance Premiums
3) Tax-Free Fringe Benefits