When to Consider Conversion
From a tax perspective, it makes sense to convert an LLC into an S-Corp when the self-employment tax exceeds the tax burden faced by the S-Corp. In general, with around $40,000 net income, you should consider converting to S-Corp. Depending on your circumstances, the breakeven point could even be as low as $25,000 net income.
S-Corp Election Deadline
It is important to note that one must convert to an S-Corp by March 15 in order to be applicable for the following year. If you miss this deadline, you may apply for late election relief if you have a valid reason.
Advantages of S-Corp Status
An S-Corp can reduce self-employment tax liability. LLC members must pay self-employment taxes on the entire profits of the business, while S-Corporations only pay taxes on salaries paid to shareholders. There is also more flexibility in distributing profits and dividends in an S-Corp.
Election Criteria and Timeline
To be eligible to elect S-Corp taxation, you’ll need to meet certain requirements. One of the main criteria to convert an LLC to an S-Corp is to have at most 100 owners or members. A workaround that the IRS allows is to treat individual family members as one family ‘shareholder’.
Submitting Form 2553 can be done at any point in the current tax year to begin converting an LLC to an S-Corp for the following tax year. The deadline is within ten weeks and five days of the start of the current year.
How to Convert an LLC to an S-Corp
For federal tax purposes, you can make an election for the LLC to be taxed as an S-Corporation by filling out a form and sending it to the IRS. Newly formed LLCs can file an election within two months and 15 days of the date the business begins its first tax year. In certain situations, a company can utilize S-Corp taxation even if the form is filed late.
Tax Treatment Comparisons and Processes
Single-member LLCs are taxed as sole proprietorships, while multi-member LLCs are taxed as partnerships. An S-Corp allows the owner to take distributions and a salary from the profits to minimize income tax and avoids paying the additional 15.3% self-employment taxes on the profit.
IRS Deadline & Requirements
It is important to meet clear parameters and deadlines set by the IRS to avoid penalties.
Choose the Right Time for Conversion
Determining the optimal time to transition from an LLC to an S-Corp is based on factors specific to each business owner’s circumstances and goals. Typically, the decision to switch is motivated by tax considerations and the need for a more formal business structure. It is crucial to consult with a qualified tax professional for personalized guidance.