Sole proprietorship to s corp mid year

For any type of eligible business structure, the conversion to an S corp is official when the Internal Revenue Service approves it. Unfortunately, a sole proprietorship business isn't eligible to directly convert to an S corp. This doesn't mean, however, that the S corp designation is permanently out of reach: You just have an additional requirement to satisfy before the conversion can occur.

Entities Eligible to Make S Corp Election

A business entity must be eligible to make an election to be taxed as a C corporation, or actually be incorporated, to make an S corp election. As a result, only businesses organized as partnerships; limited liability companies, or LLCs; and corporations are eligible. If your goal is to be taxed under the S corp rules, it's necessary to form a corporation or single-member LLC first.

Forming the Entity

State laws govern the formation of corporations and LLCs, though creating either entity is generally subject to similar procedures regardless of the jurisdiction. To form a corporation, for example, you'll need to choose a legal name for it that isn't already in use or too similar to one that is. You then prepare the incorporation documents, which are usually referred to as articles of incorporation. These documents are filed with the appropriate state agency charged with filing business entity formation documents -- in many jurisdictions the secretary of state's office. Your corporation officially exists once the state accepts your formation documents and the filing fee. Creating an LLC generally requires the same types of formalities as forming a corporation.

When the Election Is Official

Once your LLC or corporation is created, you can then file Form 2553 with the IRS to make the S corp election. The conversion, or election, is official when the IRS reviews and accepts the 2553. According to the tax agency, you should receive notification of whether the election is accepted within 60 days of filing Form 2553. If you make the election no later than two months and 15 days after the first day of the tax year you use as a sole proprietor, the S corp election is effective for that entire tax year. Filing Form 2553 after the two months and 15 days may delay the S corp's effective date to the next tax year. An S corp is just a tax designation; it isn't an actual entity. This means the LLC or corporation you form continues to exist.

S Corp Tax Implications

Filing business taxes as an S corp has some advantages to business owners. If you form a corporation, the election effectively eliminates the double taxation that affects C corporations; profit distributions to S corp shareholders aren't treated as taxable dividends, because S corp shareholders report their respective shares of business profits on their own returns and taxes are only paid once. Another benefit is that a shareholder doesn't have to pay self-employment tax on his entire share of profits as sole proprietors and partners do. Instead, if you pay yourself a reasonable salary, you'll only owe self-employment tax on those wages, but not on profit distributions.

References

Writer Bio

Michael Marz has worked in the financial sector since 2002, specializing in wealth and estate planning. After spending six years working for a large investment bank and an accounting firm, Marz is now self-employed as a consultant, focusing on complex estate and gift tax compliance and planning.

You can switch your limited liability company's (LLC) tax status to an S corporation, provided it meets the Internal Revenue Service's (IRS) requirements. You don't have to change your business structure, but you'll need to file a form with the IRS.

Electing a new tax classification can have significant financial consequences, so it's best to go over your options with a tax professional before deciding what to do.

LLC vs. S Corp.

Many small businesses are organized as limited liability companies. Compared to corporations, LLCs have more management flexibility and fewer legal requirements.

The default LLC tax system is simple, too. LLCs with one owner are taxed like sole proprietorships, and multi-owner LLCs are taxed like partnerships. The LLC's owners, known as members, pay self-employment taxes and report business income and expenses on their personal tax returns.

An LLC can also elect to be taxed as an S corporation, even if it only has one owner. Electing S corp. taxation doesn't convert your business structure from an LLC to a corporation. It simply changes the way you file and pay taxes and handle owner income. Switching to an S corp. may make sense if the financial benefits outweigh the administrative hassles.

A major reason for choosing S corp. taxation is to save money on self-employment taxes.

• If an LLC is taxed like a sole proprietorship or partnership, owners are self-employed, and they pay Social Security and Medicare taxes on all business profits, up to federal limits.
• If an LLC is taxed as an S corp., the owners can be company employees. They must pay themselves a reasonable salary for the kind of work they do. They'll pay Medicare and Social Security taxes on that salary, but not on any additional company profits.

Owners of an S corp. may be able to put more money in tax-deferred retirement accounts than they could otherwise. But switching to an S corp. can also mean additional paperwork and expense, especially if you don't already have other employees.

You'll need to run payroll, you may have to enroll in state workers' compensation and unemployment programs, and you may have additional tax forms to file.

Can I Change My Business From LLC to S Corp.?

An LLC can't elect S corp. taxation unless it meets IRS requirements for S corp. ownership and organization. Under IRS regulations, an S corp. must:

• Be a U.S. business
• Have no more than 100 shareholders (owners). Shareholders can be individuals and certain trusts and estates. Shareholders can't be corporations, partnerships, or non-resident aliens
• Have only one class of stock

An LLC that doesn't meet these requirements can't convert from LLC to S corp.

How to Change from LLC to S Corp.

To make an LLC to S corp. election with the IRS, you need to file form 2553 Election by a Small Business Corporation. The form must be signed by shareholders and an officer of the company. If you want your election to be effective for the entire tax year, it should be filed:

• By March 15 of the year you want the election to take effect.
• Any time during the prior tax year.

Newly formed LLCs can file an election for the LLC to be taxed as an S corp. within two months and 15 days of the date the business begins its first tax year.

In some situations, a company can take advantage of S corp. taxation despite filing the form late. A tax professional can advise you on timing, how to convert an LLC to an S corp., and how to prepare and file LLC as S corp. taxes.

Whether you're setting up a new LLC or you've been in business for a while, it's worth considering whether a multi-member or single-member LLC to S corp. conversion will save you money. It can be a complicated equation, so it's a good idea to run the numbers and get legal and financial advice before you decide.

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