How to Convert a Single Member LLC to an S Corp
An S Corp election for a single-member LLC alters how profits are taxed, creating a distinction between owner salary and business distributions.
A single-member limited liability company, or SMLLC, is a business structure that, by default, is taxed as a “disregarded entity.” This means the IRS treats the business and its owner as a single taxpayer, with all profits and losses reported on the owner’s personal tax return. An S Corporation is not a legal business structure but a tax election available to certain LLCs and corporations. Opting for this election changes how the federal government taxes the business’s profits. Legally, the business remains an LLC, as the S Corp designation is purely for tax purposes.
Key Tax Implications of an S Corp Election
The primary tax motivation for a single-member LLC to elect S Corp status is the potential reduction in self-employment taxes. By default, all net profits of an SMLLC are considered self-employment income, which is subject to both Social Security and Medicare taxes, known as SECA tax. This tax is levied on the entirety of the business’s earnings, regardless of how much the owner withdraws for personal use.
When an LLC elects to be taxed as an S Corp, the owner who works in the business is treated as an employee and must be paid a “reasonable salary” for the services performed. This salary is subject to payroll taxes (FICA), which are split between the employer and employee. Any profits remaining after the salary is paid can be distributed to the owner as dividends, which are not subject to self-employment or FICA taxes.
For example, an SMLLC with a net profit of $120,000 would have that full amount subject to self-employment taxes. The 15.3% rate consists of 12.4% for Social Security and 2.9% for Medicare, resulting in a tax liability of approximately $18,360.
If that business elected S Corp status with a reasonable salary of $60,000, only the salary would be subject to payroll taxes. The FICA tax on this salary would be $9,180, split between the business and employee. The remaining $60,000 of profit could be taken as a distribution, free from FICA tax, resulting in a tax savings of over $9,000.
Eligibility Requirements for the S Corp Election
To qualify for the S Corp tax election, an LLC must meet several IRS criteria:
- It must be a domestic entity formed in the United States.
- It can have no more than 100 shareholders, who are referred to as members in an LLC.
- All shareholders must be individuals, certain types of trusts, or estates; partnerships, corporations, and non-resident aliens are not permitted as shareholders.
- It must have only one class of stock, meaning all ownership units have identical rights to distribution and liquidation proceeds.
Information and Forms Needed for the Conversion
The S Corp election is made using IRS Form 2553, “Election by a Small Business Corporation.” To complete it, you will need the LLC’s legal name, mailing address, Employer Identification Number (EIN), and its formation date and state.
On Form 2553, you must provide contact information for a legal representative, and the owner must sign, date, and provide their shareholder consent. You must also select the tax year for which the election will become effective. Always use the most current version of the form, available on the IRS website.
Filing Form 2553 on time is sufficient for an LLC to elect S Corp status. A timely filing is treated as an election to be taxed as a corporation and a subsequent election to be an S Corp, so a separate Form 8832 is not needed.
The Conversion Process and Deadlines
The S Corp election has strict deadlines. To be effective for the current tax year, Form 2553 must be filed within the first two months and 15 days of that tax year’s start, which is March 15 for calendar-year businesses. To be effective for the following tax year, the form can be filed at any time during the current year.
The completed form must be sent to the IRS service center designated for your business’s state, with addresses listed in the form’s instructions. After processing, the IRS will send a confirmation notice that the election was accepted. This notice should be kept with the company’s permanent records.
Businesses that miss the filing deadline may still get relief. IRS Revenue Procedure 2013-30 allows for late election relief if there was reasonable cause for the delay. This relief is requested on Form 2553 by following the instructions in Part I and attaching a statement explaining the late filing.
Ongoing Compliance After the S Corp Election
After the S Corp election is approved, the business has new compliance responsibilities, primarily the requirement to pay the owner-employee a reasonable salary. The IRS requires the salary to be comparable to what a similar business would pay for the same services. This rule prevents owners from minimizing payroll taxes by taking a low salary and classifying most profits as distributions.
The owner’s new employee status requires formal payroll administration. The business must register for payroll tax accounts, withhold income and FICA taxes from the owner’s salary, and make matching employer FICA contributions. These taxes are reported to the IRS using forms like Form 941, “Employer’s QUARTERLY Federal Tax Return,” and Form 940, “Employer’s Annual Federal Unemployment (FUTA) Tax Return.”
The annual tax filing process also changes. The business will no longer use Schedule C on the owner’s Form 1040. Instead, it must file a separate corporate tax return, Form 1120-S, which reports the company’s income, deductions, and profits. A Schedule K-1 is generated from this return, detailing the owner’s share of income and deductions to be reported on their personal Form 1040.