Converting Your Business Entity: LLC to S-Corp and Beyond

Why Convert?

Businesses evolve. The structure that made sense when you were earning $50,000 a year may not make sense at $300,000. The entity you chose as a solo operator may not work when you add partners or seek investors. Converting your business entity is more common than you might think — and less scary than it sounds if you plan it right.

Understanding the Two Types of Conversion

There are two fundamentally different types of entity conversion, and it is critical to understand the distinction:

1. Tax Election Changes (Simple)

This changes how the IRS taxes your entity without changing your legal structure. Your LLC stays an LLC — you just change the tax treatment.

• LLC to S-Corp taxation: File Form 2553
• LLC to C-Corp taxation: File Form 8832
• S-Corp back to C-Corp: Revoke the S election (written statement to IRS)

These are relatively straightforward and do not require changing your state registration, operating agreement (in most cases), or legal identity.

2. Structural Conversions (Complex)

This changes the actual legal entity — for example, converting an LLC into a corporation or vice versa. This involves state-level filings, potentially new formation documents, and more significant legal and tax implications.

LLC to S-Corp Tax Election

This is by far the most common conversion for small businesses. You keep your LLC but elect S-Corp tax treatment to save on self-employment taxes.

How to do it:

1. File Form 2553 with the IRS by March 15 of the tax year you want the election to take effect (or within 75 days of forming a new entity).
2. All members must consent by signing the form.
3. Set up payroll for all member-employees. You must pay yourself a reasonable salary.
4. Update your books to track salary, payroll taxes, and owner distributions separately.

Tax implications:

• Income up to your salary is subject to payroll taxes.
• Distributions above your salary are not subject to self-employment tax.
• The entity files Form 1120-S instead of Schedule C or Form 1065.

State considerations:

• Some states require a separate S-Corp election filing.
• Some states do not recognize S-Corp status (New Hampshire, Tennessee for certain entities).
• California imposes a 1.5% franchise tax on S-Corp net income.

LLC to C-Corp Tax Election

Less common for small businesses, but sometimes needed when preparing for investor fundraising.

How to do it:

1. File Form 8832 (Entity Classification Election) with the IRS.
2. The election can be effective up to 75 days before the date of filing, or up to 12 months after.

When this makes sense:

• You are preparing to raise venture capital and want to test the C-Corp tax waters before fully converting.
• You plan to retain significant earnings in the business.
• You have or expect foreign shareholders.

Revoking an S-Corp Election

If the S-Corp election no longer makes sense — perhaps your income dropped, or you want to bring on ineligible shareholders — you can revoke it.

How to do it:

1. Submit a written statement to the IRS signed by shareholders owning more than 50% of outstanding shares.
2. If filed by March 15, the revocation takes effect for the current tax year.
3. If filed after March 15, it takes effect the following tax year (unless you specify a future date).

Once revoked, you generally cannot re-elect S-Corp status for five tax years without IRS consent.

Structural Conversion: LLC to Corporation

Some situations require an actual legal conversion, not just a tax election. This is common when:

• Investors require a corporate structure (not just C-Corp taxation)
• You want to issue traditional stock with certificates
• You need a board of directors structure for governance
• You are preparing for an acquisition where the buyer wants a corporation

Three methods:

Method 1: Statutory Conversion (Simplest)

Many states now allow a direct statutory conversion from LLC to corporation. You file a Certificate of Conversion and Articles of Incorporation with the Secretary of State. The entity keeps the same EIN, contracts, and assets — everything transfers by operation of law.

This is the cleanest method where available.

Method 2: Statutory Merger

The LLC merges into a newly formed corporation. The corporation survives and absorbs all assets, liabilities, and contracts of the LLC. This requires forming the new corporation first, then filing a plan of merger.

Method 3: Asset Transfer and Dissolution

The LLC transfers all assets to a new corporation in exchange for stock, then dissolves. This is the most cumbersome method and can have adverse tax consequences if not structured properly. Avoid this method if either of the first two is available.

Corporation to LLC Conversion

Less common but sometimes needed when a corporation's formality becomes burdensome and the owners want the flexibility of an LLC.

The same three methods apply (statutory conversion, merger, or asset transfer), just in reverse. The tax implications of converting a C-Corp to an LLC can be significant — it may be treated as a corporate liquidation, triggering tax on built-in gains. Get professional tax advice before proceeding.

Sole Proprietorship to LLC

This is not really a "conversion" — it is a new formation. You form an LLC and transfer your business assets into it. Since a single-member LLC is a disregarded entity for tax purposes by default, this is usually tax-neutral.

Steps:

1. Form the LLC with your state
2. Get a new EIN (or keep your existing one if the IRS allows it for the new entity type)
3. Open a bank account in the LLC's name
4. Transfer assets, contracts, and licenses to the LLC
5. Update your insurance, vendor agreements, and customer contracts

Tax Traps to Watch For

Conversions can trigger unexpected tax events. Here are the big ones:

Built-in gains tax. If a C-Corp converts to an S-Corp, it faces a built-in gains tax on assets that appreciated during C-Corp status if sold within five years of the conversion.

Depreciation recapture. Transferring depreciated assets between entities can trigger recapture of previously claimed depreciation deductions.

Debt relief as income. If the new entity does not assume all of the old entity's debts, the debt relief can be treated as taxable income.

Loss of carryforwards. Net operating losses, credits, and other tax attributes may not survive certain types of conversions.

State-level taxes. Some states impose transfer taxes or sales taxes when assets move between entities, even in a conversion context.

When to Involve Professionals

Changing a tax election (LLC to S-Corp taxation) is something a good CPA can handle without significant legal involvement. Structural conversions — especially those involving C-Corp assets, multiple owners, or significant asset values — warrant both a CPA and a business attorney.

The cost of professional guidance during a conversion is far less than the cost of a botched conversion that triggers unnecessary taxes, invalidates contracts, or creates liability gaps.

Timing Your Conversion

The best time to convert is almost always at the beginning of a tax year (January 1 for most businesses). Mid-year conversions create short tax years, require prorated returns, and complicate bookkeeping. The March 15 deadline for S-Corp elections aligns with this — file early in the year for a clean transition.

Plan at least three months ahead. Gather your financial records, consult your CPA, prepare the necessary forms, and coordinate any state filings.

Bottom Line

Converting your business entity is a normal part of growing a business. The most common conversion — LLC to S-Corp taxation — is a simple form filing that can save you thousands in taxes. More complex structural conversions require more planning and professional guidance, but they are entirely manageable. The key is understanding what type of conversion you actually need, timing it right, and watching out for the tax traps that catch people off guard.