If you want to convert an LLC to an S corporation in California, the process is pretty straightforward. There are pros and cons to this decision, though, so it’s important to first understand how your business will change when you opt for that S-corp tax status.
LLC vs S Corp in California
A Limited Liability Company, or LLC, is a type of business entity whereas an S corporation is a type of tax classification. In other words, if you convert an LLC into an S corp, you’re maintaining the same basic entity structure (albeit with some modifications) but asking the IRS to tax your business as a Subchapter S Corporation rather than an LLC. C corporations can also request to be taxed as S corps if they meet certain eligibility requirements.
To break it down a bit more, a single member LLC operates similarly to a sole proprietorship by default. It benefits from pass-through taxation, meaning that all business profits are automatically “passed through” to the owner’s personal tax return in the form of self-employment tax. Since there’s no corporate tax rate, there’s no threat of double taxation. It’s important to note, however, that both LLCs and S corporations are still subject to California’s $800 minimum franchise tax, so you still have some corporate tax liability.
While the tax benefits of an S corp conversion can be significant, there are also a lot more legal requirements that come with an S corp status.
Should You Convert an LLC to an S Corp in California?
The decision of whether or not to convert to an S corp rests on the size, structure, and goals of your business. By default, LLCs and S corps share many of the same features:
Both benefit from pass-through taxation in California (though not in all states).
Both offer limited liability protection, meaning that business owners, employees, and shareholders are not personally responsible for the company’s debts or liabilities (there are a few legal exceptions to this rule).
Both have strict filing requirements, although the filing requirements for an S corp are much more stringent
Both can add legitimacy and credibility to a small business operation. .
Criteria for Establishing S Corp Status in California
In order to establish an S corporation in California, your LLC must meet all of the following criteria:
An S corp can have no more than 100 shareholders
An S corp can carry only one class of stock
All S corp shareholders must be legal U.S. citizens or residents
All S corp shareholders must be individuals, estates, or eligible trusts; other corporations and partnerships do not qualify as shareholders
In addition, certain types of LLCs do not qualify for an S-corp tax structure. These include certain financial institutions, insurance companies, and international sales corporations.
How to Convert Your LLC Into an S Corp in California
California has streamlined the statutory conversion process. So while some states will require you to establish a separate corporate entity and then convert your LLC assets, California makes it easy to transfer all of your assets and liabilities with just a statement of conversion and new Articles of Incorporation.
If you meet the qualifications, here’s how to convert your California LLC into an S corp:
Fulfill the requirements of incorporation:
Draft a set of corporate bylaws (you can use the bylaws from your original LLC Operating Agreement if they’re applicable).
Elect corporate officers and appoint corporate directors
Issue stock certificates
Conduct your initial board meeting
Establish a plan of conversion according to the stipulations of CA Code Section 17540.3. The plan should include:
The name of your new S corp
The terms and conditions of your conversion (including how you intend to convert your LLC membership interests)
The provisions in the Articles of Incorporation to which shareholders will be bound
The place of the organization (for both the LLC and newly established S corp)
Any other agreements or provisions that are required for your business or agreed upon by all members therein
Have the existing members of the LLC sign the plan of conversion (if the LLC has multiple members). California law usually requires the plan to be approved by a majority of members, though there are exceptions to the rule.
File new Articles of Incorporation along with a statement of conversion. You can file your own articles with the California Secretary of State, or you can use Form CONV LLC-GS.
Pay the $150 filing fee when submitting your new Articles of Incorporation. If you’re submitting the paperwork in person, a separate $15 counter drop-off fee also applies. If you need to fast-track your application, you can request expedited service for an additional fee.
File a Statement of Information within 90 days of submitting your Articles of Incorporation. This is submitted to the Secretary of State and includes your basic corporate info including your members, officers, directors, address, and contact information. You’ll need to submit a new Statement of Information every year.
Complete IRS Form 2553, Election by a Small Business Corporation. Submit this form to the Internal Revenue Service for federal tax purposes.
Once the conversion process is complete, your business must adhere to all general rules and requirements that apply to a California corporation. These include:
Holding annual shareholders' meetings and directors' meetings.
Maintaining a record of minutes of all major decisions from directors and shareholders.
Submitting a new Statement of Information every year (instead of every two years as you would with an LLC).
Important note: If you want the tax implications to be valid for the same calendar year, you’ll need to complete the state and federal filing process by March 15th of that year. Otherwise, the change will take effect the following year.
S-Corporation Status Is Within Reach for Your LLC
Converting an LLC to an S corp isn’t the right solution for everyone, but it can be an excellent choice if you’re looking to grow your corporate membership or take advantage of the unique tax benefits.
Our Los Angeles CPA firm specializes in assisting businesses through this transition. If you do decide to make the switch, we recommend working with tax and legal professionals who can equip you with financial and legal advice and help you to navigate the complexities of statutory conversion.
This will make the process move much faster and more smoothly while ensuring that your corporation is legally sound and poised for maximum success.