William Bronchick – LLC to S Corp Conversion Kit
From: Attorney Bill Bronchick
Re: Single-Member LLC Conversion to S Corp
Do you have a single-member (single-owner) LLC? If you are the sole member, you may be paying too much in taxes! Most small-business people set up an LLC as “single-member”, either with themselves as the sole owner or husband and wife as the owners. In doing so, they elected the default tax designation, which is called “disregarded”. What this means is that the LLC is ignored for federal income tax purposes, and the member or members report their business activity on their PERSONAL tax return, form 1040. They do it this way because it’s simple and easy for reporting or because they simply don’t know any better.
SO, WHATS THE PROBLEM?
The problem with reporting your business activity on your personal return is that if you are generating earned (aka “ordinary” or “active”) income, your profits are subject to not only federal income taxes, but also SELF-EMPLOYMENT taxes (Social Security, Medicare, etc). If you enjoy this government “nanny” system where you pay into a big government “fund” that you MIGHT get back someday at retirement, then read no further. But if you want to save thousands of dollars a year, then PAY ATTENTION!
Savvy small business owners often form an S corporation for earned income activities. The reason for this is to avoid a chunk of the self-employment tax. An S corporation is a “pass-through” entity, which means there is no federal income tax; the owners report the net income (or loss) on their personal return. This type of income is NOT subject to self-employment tax! If you are netting $50k or more in your business, that’s a HUGE tax savings. You can’t, however, eliminate ALL of your self-employment tax liability; the IRS expects that you take some “reasonable” salary from your S corp, which is subject to payroll taxes (similar to self-employment tax). However, you do NOT have to take all of your profit as salary. Even if you take HALF of your profit as salary and half as a distribution from the S corp, you slash your taxes by THOUSANDS of dollars each year.
ATTENTION REAL ESTATE INVESTORS…
If you are a landlord, you don’t have to be worried because rental income is generally not considered “earned income” and thus not subject to self-employment tax. As a “disregarded” LLC, you would report this income on your 1040, schedule “E” (versus earned income, which is reported on schedule “C”). However, if you flip or wholesale properties, the IRS could tag you as a “dealer”, which makes your real estate activity a BUSINESS, not an investment. Thus, your earnings would be reported on Schedule “C”, subject to self-employment tax. Imagine three years of flipping activity during which you earn $100,000 in net profit, reporting the activity as short-term capital gains (not subject to self-employment tax). The IRS audits you and moves the income to schedule “C”, and hits you with self-employment tax, PLUS interest and penalties. OUCH! For any short-term deals, ESPECIALLY wholesaling, you may consider an S corporation for this activity.
Also, keep in mind that short-term rentals, such as VRBO and AIR BNB are generally considered “serviced” rentals and thus will be treated as earned income, not rental income.
THE “FIX” – IT’S EASIER THAN YOU THINK!
You don’t need to start all over to have the benefits of an S corporation. If you have an existing “disregarded” LLC, you can convert it for tax purposes to an S corporation and STILL be an LLC! That’s right, you can have the simplicity of the LLC, keep your existing name and bank account, keep your existing EIN number, yet be treated for federal income purposes as an S corporation. The conversion takes a few IRS forms, an updated operating agreement, and a new setup of your accounting records. And, you don’t necessarily need an attorney or CPA to do the conversion because I’ve created the first of its kind, LLC to S Corporation Conversion Kit!
HERE’S WHAT YOU GET WITH THE KIT…
My downloadable kit comes complete with the following: