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As a result of the Tax Cuts and Jobs Act, the new QBI deduction, the ability to potentially avoid some FICA tax and better fringe benefit treatment, the “S” election has become an extremely popular tax election for LLC’s.
Does the built-in-gains tax concern apply?
Built in gains tax concerns do not apply when converting from an LLC taxed as a partnership or as a sole proprietor to an S Corporation.
Do all members have to agree to the conversion?
Each member of the LLC who is an owner at the time of the election must sign the election, and a member must sign as an officer if he or she represents under penalties of perjury that they have the authorization to sign.
If an election is to be effective for any period prior to the time it is filed, each person who was an owner between the date the election is to be effective and the date the election is filed, must sign.
What forms have to be filed with the IRS?
IRS Form 8832 is NOT required to be filed under Revenue Procedure 2004-48, Form 2553 is required and filed with the IRS Service Center for the taxpayer’s state. The new S corporation will utilize the same FEIN as the LLC. Under Regulation 301.7701-3(c)(1)(v)(C) if the LLC timely files the S corporation election Form 2553, the entity is considered to have made the election to be taxed as a corporation effective on the date the S election is effective.
A number of late filing provisions are available as discussed in the Business Tax In Depth manual. The election to be taxed as an “S” corporation will not generally qualify for Section 1244 ordinary loss treatment because no stock is actually issued.
When are the forms due, when is the election effective and how are they filed?
The election to be taxed as the new entity will be in effect on the date the LLC enters on line E of Form 2553. However, if the LLC does not enter a date, the election will be in effect as of the form’s filing date. The election cannot take place more than 75 days prior to the date that the LLC files Form 2553 and the LLC cannot make the election effective for a date that is more than 12 months after it files Form 2553. However, if the election is the “initial classification election,” and not a request to change the entity classification, there is relief available for a late election (more than 75 days before the filing of the Form 2553).
Rev. Proc. 2004-48 provides guidance for requests for relief for late filed Forms 8832. Rev. Proc. 2009-41 (and others) extends late entity classification relief to both initial classification elections and changes in classification elections. This revenue procedure also extends the time for filing late elections to within three years and 75 days of the requested effective date of eligible entity’s classification.
Even a 1-owner LLC may elect to be taxed as a “S” corporation utilizing Form 2553.
Are there any special tax elections that must or should be made on conversion by the company?
There are no required or even suggested elections upon conversion. However the tax adviser must understand that for tax purposes the entity is now an “S” corporation, meaning all “S” corporation rules apply, including distributions, fringe benefits, wages, etc.
If the election is incorrectly completed the LLC will be treated as if they were a “C” corporation not an LLC!
Step-up basis elections are not available for this type of conversion.
S corporations with greater than $25 million in revenues are required to use the accrual method of accounting under the 2017 Tax Cuts Act.
Is the conversion taxable to the company, and if so, how much and what type of income and what is the effect on asset bases?
The conversion is non-taxable to the LLC or the S Corporation. The LLC’s asset bases transfers to the C Corporation without modification using the same method, accumulated depreciation and remaining life. None of the converted assets re-qualify for bonus depreciation or Section 179 write-off.
Is the conversion taxable to the owners, and if so, how much and what type of income?
The conversion is generally not taxed to the members. Note that this conversion does not make the ownership interest now qualify for special 1244 ordinary loss rules available to original shareholders in small C corporations. If the member had previously used debt basis to deduct losses in excess of contribution basis, it is possible that a taxable event will occur on conversion to bring contribution basis equal to zero.
Are there any special tax elections that must or should be made on conversion by the shareholders?
Are there any special forms that must be provided to the shareholder’s upon conversion?
What are the owner’s ownership bases (not counting debt) after conversion?
The member’s basis in the new corporate form will be equal to the contribution basis of the old LLC on an investor-by-investor basis. The basis will not include any basis from debt.
Disclaimer: The views and opinions expressed in this article are those of the authors and do not necessarily reflect the official policy or position of Manning & Associates and / or MANNINGTAX.COM. This information is published for informational purposes only.