Inform all creditors, clients, shareholders, and employees of the change. File a Certificate of Dissolution with the Secretary of State's office. Create a new LLC. Transfer your existing S Corp's assets, liabilities, and ownership over to the new business.
When you form an LLC, you will need to transfer assets into the company in order to properly capitalize the business. If you have business partners, they too will contribute assets in exchange for an ownership percentage. Capitalization is critical to your LLC.
In 1996 Congress enacted amendments to the S corporation rules to permit S corporations to own 80% or more of the stock of subsidiary corporations. In the case of 100%-owned subsidiaries, this legislation further authorized S corporations to make an election (a "QSub election").
As part of your estate planning, you may need to transfer ownership of your S corporation to an entity or trust. S corporations have a special tax status, and if they are transferred to an entity that is ineligible for S corporation status, that status could be lost.
As long as the shareholders approve, there are no restrictions on purchasing property for rental purposes. There are restrictions on the income derived from the property, though. The S Corporation is taxed as a pass-through entity and profits and losses pass through to its shareholders.
S Corps that lose their “S” status must typically wait five years before being able to re-elect it. As mentioned, deliberately violating one of the rules, such as transferring stock to an ineligible shareholder, is not a good thing.
During an S corp asset sale, the corporation liquidates and distributes sale proceeds to the S corp shareholders. For tax purposes, shareholder payments are generally made under employment consulting and noncompetition agreements to avoid double taxation.
Having a California S Corporation own an LLC might provide more options for active and passive business activities, as it combines the benefits of both business structures. This can allow for a diverse and adaptable business model.
If the property has appreciated in value, a capital gains tax might apply. However, if the LLC is a single-member entity classified as a disregarded entity for tax purposes, the transfer generally has no immediate tax consequences.
“In my opinion, LLCs are your best option for owning real property, as they blend the best aspects of partnerships and corporations. With an LLC, you don't own the property, the company owns it, protecting you from much liability.”
The transfer process itself can take the form of a contract for the transfer/purchase of business assets. In the case of money transfers, these can be done as a loan or by purchasing shares in the other company, or through dividend payments if shares in the transferor company are owned by the recipient company.
Tax Benefits of Converting S Corp to an LLC
Converting an S Corp to an LLC offers several benefits once the process is complete, which is why it's an attractive option for many businesses. Some of the prominent tax benefits include: No capital gains tax.
Transferring assets to an LLC is a fairly simple process. Because LLCs (limited liability companies) are viewed as entities that can own property just like individuals, transferring assets to an LLC is much like transferring ownership to another person.
A shareholder distribution is a way to take funds out of your business without incurring payroll taxes. For a solely owned S Corporation, this is achieved by transferring funds from your business checking account to your personal bank account.
Transferring property from an S corp to an LLC
Once this is done, transferring property to an LLC from an S corp might incur hefty taxes because the property transfer may be considered a profit distribution; the S corp must acknowledge gain or loss on the distribution.
Having the S corp own your residence may sound like a great way to get free housing, but it's likely to attract attention from the IRS. Whether you are the only shareholder or one of many (up to the limit of 100 allowed) living in a house owned by the company is reasonably construed as income.
Distributions are the best way to get money from your S Corp. Because you'll report it as “passive income” on your income tax return, it won't be subject to employment taxes.
Some unique income tax rules apply to S corporations regarding compensation and fringe benefits paid to shareholders who own greater than 2% of the corporation. Under these S corp income tax rules, a greater than 2% shareholder is taxed as a partner in a partnership for fringe benefits received.
Because of the one-class-of-stock restriction, an S corporation cannot allocate losses or income to specific shareholders. Allocation of income and loss is governed by stock ownership, unlike partnerships or LLCs taxed as partnerships where the allocation can be set in the partnership agreement or operating agreement.
At the end of each year, all S corporation profits are allocated to the corporation's shareholders. Even if you and your fellow shareholders choose to leave some or all of the profits in the corporation, taking nothing as distributions or salaries, you will still be required to pay tax on those profits.
What is the 60/40 rule? The 60/40 rule is a simple approach that helps S corporation owners determine a reasonable salary for themselves. Using this formula, they divide their business income into two parts, with 60% designated as salary and 40% paid as shareholder distributions.
The direct answer to whether an S Corp can pay a shareholder's mortgage is no. Personal expenses, including mortgage payments, cannot be directly paid by the corporation without significant tax implications and potential violations of IRS regulations.
For tax efficiency, most company directors will choose to pay themselves a low salary and take any further money from the company in the form of dividends. This is because dividends are taxed at a lower rate than salary, and avoid national insurance contributions.