Question

Explain some of the pros and cons of converting a C Corporation into an S Corp?
Further, if limited liability companies and S corps are both taxed as flow-through entities for tax reasons, explain why might an owner choose one form over another? List out some of the factors to consider.

Answer 1

Following are the Pros and Cons of converting a C Corporation into an S Corp: -

Sr. No.	Pros	Cons
1	The main advantage is that an S corp does not pay a corporate-level income tax. So any distribution of income to the shareholders is only taxed at the individual level.	An S corp cannot have more than 100 shareholders, meaning it can’t go public and limiting its ability to raise capital from new investors.
2	The Tax Cuts and Jobs Act of 2017 gave eligible S corp shareholders a deduction of up to 20% of net “qualified business income”.	Shareholders must be individuals (with a few exceptions) and U.S. citizens or residents. This also makes it harder for an S corp to obtain equity financing, particularly because venture capital and private equity funds tend to be ineligible shareholders.
3	The losses of an S corp pass-through to its shareholders, who can use the losses to offset income (subject to restrictions of the tax law).	To be eligible for S corp status the corporation cannot have different classes of stock. Some investors want preferences to distributions or other privileges. An S corp cannot provide that.
4	-	Most S corps will restrict their shareholders’ ability to sell or transfer their shares. That’s to make sure they don’t end up with an ineligible shareholder which will cause the IRS to terminate its S corp status. This makes it harder for the shareholders of an S corp to exit the corporation.

Following are the factors which need to consider while choosing between LLP and S Corp: -

If both entities have same tax rate structure then the most important factors are as follows: -

A "C corporation" might be the right business type for you if you:

• May need venture capital for financing
• Want flexible profit-sharing among owners
• Want company earnings to stay in your business so that it can grow
• Want flexibility to spread the business earnings between the corporation and shareholders for tax-planning purposes
• Want flexibility to set salaries for employees/owners to minimize Social Security and Medicare taxes
• Want flexibility to provide (through the corporation) substantial health and medical benefits and other fringe benefit programs for things like education, life insurance, and transportation costs
• Want to be able to easily sell your business
• Want to provide an accountable plan for travel & entertainment
• Want to be able to offer stock options to employees
• Expect your business to own real estate
• Prefer to lower your risk of IRS audit exposure, since there is a higher audit rate for business income that is reported solely on Schedule C of Form 1040 (U.S. Individual Income Tax Return)

Limited liability company (LLC)

Another business type that is formed under state law and gives you personal liability protection is the LLC. Tax-wise, an LLC is similar to an S corporation (or S corp), with business income and expenses reported on your personal tax return. If you are the only owner of an LLC, you are viewed as a “disregarded” entity. This means you report the LLC’s income and expenses on Schedule C of Form 1040─the same schedule used by sole proprietors.An LLC might be the right type of business for you if:

• Your startup company anticipates losses for at least two years and you want to be able to pass the losses through to yourself and the other owners
• Flexibility for accounting methods is desired, because LLCs are not required to use the accrual method of accounting as C corporations typically are
• Your business may own real estate
• You want management flexibility, since LLCs offer more flexibility than corporations in terms of how the management of the business is structured
• You wish to minimize ongoing formalities; unlike corporations, which are required to hold annual meetings of directors and shareholders and keep detailed documents and records for all corporate meetings and major business decisions, LLCs do not face strict ongoing meeting and documentation requirements
• You want flexibility for sharing profits among owner