If you’ve talked to Diane or I in the past year about choice of entity, we’ve probably told you about our favorite combination, the LLC taxed as an S Corporation. But what about those of you who already have a business? Do you change it, or do you start over? And what are the tax consequences of making a switch? A new letter ruling just released by the IRS offers good news!
The reason Diane and I like the LLC-S combination so much is that it gives you a fantastic combination of asset protection and tax savings. Many people know that your LLC interests are protected by law in most states, from being seized by creditors. So if you get sued, your LLC interests (and by extension everything IN your LLC) are protected. But not as many people know that your shares in a corporation, C or S, are NOT protected in the same way. Now if you get sued, those shares – and everything in your S Corporation – are at risk.
This difference in legal protection is usually the catalyst for change, but the devil is in the details – and in this case, in the taxation of the assets held within the S Corporation when the change is made. When you roll assets out of an S Corporation and into an LLC, there is often a capital gain due to the assets gaining in value. Depending on how much the gain is, you can wind up paying capital gains tax even though nothing really changed in the business, the assets or the ownership, AND you are just moving them from one entity to another.
But the new letter ruling helps us out here, by stating that you can make the change from an S Corporation to an LLC taxed as an S Corporation without disturbing anything. In fact, the IRS has made it easy, by allowing you to contribute all of your S Corporation stock and property into an LLC, in exchange for your 100% ownership in the LLC. Your S Corporation status doesn’t terminate, there is no capital gain – it’s just a straightforward entity conversion. File some paperwork with the Secretary of State, make sure you have some Minutes documenting the change, prepare the new Operating Agreement and other documents, and you’re done. (I can help you with that if you need it – email me at firstname.lastname@example.org to learn more).
So if you started your S Corporation on a shoestring years ago and have put off the conversion because you didn’t want a tax bill, this letter ruling makes the decision a lot more affordable!