Whereas an LLC, or limited liability company, is a business entity formed under state law, a subchapter S corp is a tax code designation recognized by the IRS. It is possible to change your LLC’s tax treatment to that of an S corp without converting your business to a corporation for other purposes. Alternatively, you could incorporate a new business and transfer the LLC’s assets.
S Corp for Tax Purposes Only
File Form 8832 with the IRS to have the company taxed as a corporation. By default, the IRS treats single-member LLCs as sole proprietorships and multiple-member LLCs as partnerships. The members of an LLC can unanimously elect to be taxed as a corporation by filing this form. In some situations, this designation can be applied retroactively to previous tax years.
Make changes necessary to meet S corp qualifications. The IRS defines corporations eligible for S corp treatment as domestic companies with no nonresident alien members, having fewer than 100 total members/owners and only one type of stock -- ownership units. Additionally, other business entities except for tax exempt entities cannot be owners of the company and certain types of financial institutions cannot be S corps. IRS Form 2553 details the specifics for qualifying as an S corp.
File Form 2553 with the IRS to elect for S corp treatment. If you file the form with your individual tax return, the election can be effective for the tax year for which you’re filing the return. Otherwise, the election will not be effective until the following tax year unless the form is filed within 2 months and 15 days from the start of the company’s tax year.
Conversion or Merger
Submit a business entity conversion form to the same state agency that processes business entities, if available. Where available, this single form dissolves the LLC, incorporates a new business and transfers the assets to the new corporation -- an "automatic" conversion.
Effectuate a merger. Where a single conversion form is not available, incorporating a new company and merging the LLC into it achieve the same basic effect. But how the assets or interests of the LLC reach the new company will affect the tax basis of the shareholders and have other tax implications..
Submit Form 2253 to elect for S corp taxation. Once you've incorporated your new business, which must meet the S corp qualifications, you can elect to be taxed as an S corp by filing the appropriate form with the IRS.
The IRS deems conversion by single form to consist of the LLC transferring all its assets to the corporation in exchange for stock, and then liquidating this stock for distribution to the members. In the end, the individual members of the now defunct LLC are shareholders in the new corporation. Previously unrealized changes in the value of the LLC's assets are treated as capital gains or losses. If a merger is effectuated manually, it may be possible to distribute the assets and liabilities of the LLC to the individual members, who then contribute them to the corporation in exchange for stock. It is also possible for the members to transfer their interests in the LLC to the corporation in exchange for stock.
The corporation itself is not required to file a tax return, but should complete Form 1120S for its own records.
Joseph Nicholson is an independent analyst whose publishing achievements include a cover feature for "Futures Magazine" and a recurring column in the monthly newsletter of a private mint. He received a Bachelor of Arts in English from the University of Florida and is currently attending law school in San Francisco.