Asset Protection: Convert Your S-Corporation to a Limited Liability Company
By: Morris Law Group - June 12, 2013
Operating a business as an S-corporation can avoid some self-employment taxes. Self-employment tax consists of Social Security and Medicare taxes withheld from the pay of most wage earners. Any profits passed through to a shareholder, rather than paid out as wages, will result in a self-employment tax savings. Many times, operating a business as an S-corporation can be preferable to operating it as a limited liability company ("LLC") taxes as a partnership. LLCs taxed as a partnership generally cannot take advantage of this self-employment tax savings because all profits of the LLC, whether paid out as employee compensation or passed through as profit to the members, are subject to self-employment taxes.
In most cases, the shares of corporation are subject to levy by the creditors of its shareholders. For example, assume Mike and Joe form a corporation with Mike as a 60% shareholder and Joe as a 40% shareholder. Mike is in an automobile accident of which he is at fault and is sued with a resulting judgment entered against him. The creditor may be able to satisfy the judgment with the shares of stock Mike owns in the corporation. Once the creditor takes Mike's shares, the creditor will be able to vote and potentially liquidate the corporation and take the assets that the corporation owns.
Unlike a corporation, in Florida, a multiple-member LLC is afforded "charging order protection." This means that if Mike and Joe had formed an LLC, under Florida Statutes =A7608.433(5), the "sole and exclusive remedy" that Mike's creditor would have against the LLC is to seek a charging lien against Mike's 60% interest in the LLC. If the creditor is successful in placing a charging lien on his 60% membership interest, the only thing that the creditor will be entitled to are funds from a distribution or liquidation of the LLC which Mike would have otherwise received. The creditor should not have the ability to attach the underlying assets of the LLC and will not be entitled to vote, compel distributions or otherwise be involved in the LLC. The business can continue operations. Further, it is possible that a salary can be paid out of the LLC to Mike and Joe or a loan taken from the LLC without the creditor receiving anything. As you can see, operating a business as an LLC is much better for asset protection than operating as an corporation.
An existing S-corporation can achieve the benefits of both entities by converting to an LLC for state law purposes, and electing to remain taxed as an S-corporation. The shares of the S-corporation would be converted to membership interests in an LLC. The members would retain the benefits of self-employment tax savings while affording themselves asset protection by virtue of becoming a multiple-member LLC for state law purposes. The process is referred to as an "F" reorganization. If done properly, there will be no gain or loss recognized as a result of the conversion, the tax basis in the entity would be unchanged and the resulting LLC would even take the same tax identification number as the S-corporation had prior to the conversion.
We are able to assist you in your wealth preservation by converting your existing S-corporation to an LLC for state law purposes. Please contact our office for additional information.
** Disclaimer Required by IRS Circular 230** Unless otherwise expressly approved in advance by the undersigned, any discussion of federal tax matters herein is not intended and cannot be used 1) to avoid penalties under the Federal tax laws, or 2) to promote, market or recommend to another party any transaction or tax-related matter addressed.