Tax Issues inConversion of S-Corporation To Limited Liability Company

Limited liability companies are generally better asset protection entities than corporations. A judgment debtor can levy upon the debtor’s stock in a corporation and, in the case of a small corporation, possibly stop the corporation business and liquidate corporate assets. In the case of a debtor’s limited liability company interest, the judgment creditor’s remedy is limited to a lien on distributions, if any, and the creditor cannot stop the LLC operations or force the sale of the LLC’s assets.

In the past, corporations, and particularly Sub-S corporations, were the most common business entity for closely held small businesses. When owners of small corporations become concerned about asset protection, they often want to convert their S corporations to LLCs, possibly LLCs taxed as S corporations for tax purposes.

Florida statutes provide a means to convert a domestic or out-of-state corporation to a Florida LLC. The question is whether the conversion of a corporation would be treated for tax purposes as a liquidation and would accelerate the owner’s income tax liability.

A conversion from S to an LLC can qualify as a tax-free reorganization under § 368-(a)(1)(F). In a Letter Ruling the basis and holding periods of the assets in new LLC are the same as in the prior Sub S. The S Corp status did not terminate as a result of the reorg since new LLC retained its S corp election and continued to meet S corp requirements per § 1361 (Ltr Rule 200528021). There will be issues if the ownership as a result of this re-organization changes.

Same owners, same percentages should not be a problem.

So, if a S Corporation owner wants to reorganize as an LLC taxed as an S corporation (by filing Form 8832), he should be able to do so without adverse tax effect as long as ownership does not change.