Convert LLC to S-Corp: Tax Consequences Explained
Many small business owners start with an LLC. But as your revenue grows, so does your tax bill, and understanding the convert LLC to S-Corp tax consequences becomes a lot more important if you’re considering it.
The switch can potentially save you a lot of money, but it can also add complexity you weren't really expecting. Here's what you need to know before you decide.
Not sure if an S-Corp makes sense for your business? Use our FREE S-Corp Calculator and get a personalized answer in minutes!
What Is an LLC?
An LLC separates your personal assets from your business. If the business gets sued or runs into debt, your personal finances stay protected. But you probably already know this part, and what matters more is how an LLC is taxed.
By default, a single-member LLC is a pass-through entity. The business doesn't pay taxes on its own. All the profit flows to your personal return, and you pay taxes on it there, including self-employment tax.
The self-employment tax is a whopping 15.3%, and it applies to every dollar of profit your business earns. For a business bringing in $150,000 a year, that's over $22,000 in self-employment taxes!
Multi-member LLCs work similarly. Income passes through to each owner's personal return, and each owner pays self-employment taxes on their share.
Learn more about an LLC vs S-Corp and how the taxes work.
What Is an S-Corp?
An S-Corp is not a separate legal structure. It's a tax election. Your LLC stays exactly as it is, and you file Form 2553 to ask the IRS to treat it as an S-Corp for tax purposes.
What changes is how your income gets divided and taxed.
As an S-Corp owner who works in the business, you must put yourself on payroll and pay yourself a reasonable salary. That salary goes through payroll and is subject to Social Security and Medicare taxes, just like any other employee's wages.
Any profit left over after your salary can be taken as a distribution.
Distributions pass through to your personal return but don't go through payroll, so they're not subject to those same taxes.
In other words, instead of paying 15.3% self-employment tax on everything your business earns, you only pay payroll taxes on your salary. The rest of your profit moves through at a (much) lower tax cost.
Learn more about S-Corp taxes for dummies.
Why Do People Switch From LLC to S-Corp?
Mostly to reduce their tax bill.
Once a business is generating enough profit, the gap between what an LLC owner pays in self-employment taxes and what an S-Corp owner pays in payroll taxes can be pretty big.
For many business owners, that gap is worth the added administrative work that comes with running payroll and filing as an S-Corp.
Learn if a single-member LLC can be an S-Corp.
Tax Benefits of Converting from LLC to S-Corp
The main reason business owners convert from LLC to S-Corp is to pay less in self-employment taxes. But there are a few other advantages that apply, too.
You only pay self-employment taxes on your salary, not your total profit
As an LLC, all your profit is subject to the 15.3% self-employment tax. As an S-Corp, only your salary goes through payroll. The rest of your profit comes out as distributions, which aren't subject to Social Security or Medicare taxes.
If your business makes enough money to comfortably pay yourself a reasonable salary and have enough left over for meaningful self-employment tax savings, the switch from an LLC to S-Corp can make a big positive difference.
Your business expenses stay deductible
Converting to an S-Corp doesn't change what you can deduct. You can still write off legitimate business expenses the same way you did as an LLC.
You may be able to contribute more to retirement accounts
S-Corp owners who pay themselves a salary can contribute to a Solo 401(k) based on that salary, which in some cases opens up higher contribution limits than a self-employed LLC owner would have.
Your business gains credibility with lenders and investors
This one isn't purely a tax benefit, but it's worth thinking about. Having a formal payroll structure and corporate tax filings can make your business look more established when you're applying for financing or bringing on investors.
What Are the Disadvantages of S-Corp Over LLC?
The tax savings on your business income can be great, but there's also an added workload to consider when you switch to the S-Corporation status:
You're required to run payroll, which means regular paychecks, tax withholdings, and remittances to the IRS
You must file Form 941 every quarter to report payroll taxes, on top of your existing tax filings
You need to issue yourself a W-2 at the end of every year
Payroll software or a payroll service becomes a necessary expense
Your state may have additional fees, franchise taxes, or filing requirements for S-Corps that don't apply to LLCs
If your salary isn't set correctly, the IRS may audit you and reclassify your distributions as wages, which wipes out your tax savings and adds penalties
None of these are dealbreakers, but overall your business needs to be generating enough profit to justify the cost and effort of maintaining the S-Corp structure.
Learn more about whether or not an S-Corp is worth it.
At What Point Should You Switch from LLC to S-Corp?
There's no one hard, universal number.
Typically, for most businesses, you should be making somewhere around $60,000 to $100,000 in net profit for the S-Corp election to make financial sense.
Below that level, the tax savings are often smaller than the cost of running payroll and managing the additional filings.
But it can vary from business to business.
The cleaner way to think about it is that if the amount you'd save in self-employment taxes is larger than the cost of maintaining the S-Corp structure, it's worth considering.
If it's not, switching to an S-Corp may not be the best decision for you right now.
Want a personalized answer? Use our FREE S-Corp Calculator and find out!
How to Make the Best Decision for Your Business
Converting to an S-Corp is a tax strategy, and like any strategy, it needs to be built around your unique situation. Consider taking these steps:
Run the numbers with a tax strategist: You need projections based on your revenue, reasonable salary, and state's tax rules.
Look at your state's requirements: Some states have additional taxes, fees, or filing requirements for S-Corps that can eat into your federal savings.
Factor in your growth trajectory: If your revenue is growing quickly, converting sooner may make more sense than waiting because the savings compound as your profit grows.
Be honest about your tolerance for admin: If compliance management isn't something you're willing to take on or outsource, that's a big factor worth weighing.
Learn more about the S-Corp tax rate.
So, Is Switching to an S-Corp Worth It?
For many small business owners, yes.
Converting from an LLC to an S-Corp can reduce your self-employment tax burden and set your business up for smarter long-term growth. But keeping your S-Corp compliant is also harder, so that's a downside to consider.
Want to know if the switch makes sense for you? Use our FREE S-Corp Calculator to run the numbers!
Ready to talk through your options? Our team at Desi Tax Service® works with small business owners to build smart and clear tax strategies that keep more money in your pocket. Learn about our tax services or book a call to get started!
