Convert to LLC in the middle of 2017?

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boglerocks
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Convert to LLC in the middle of 2017?

Post by boglerocks » Tue Dec 27, 2016 7:22 am

If I convert my sole proprietorship to a single member LLC with a C corp election in the middle of 2017, how is it handled as far as income tax? Maybe I would just include the sole prop in my tax return as if it ceased operations when it was converted, and include the LLC as if it were a new business that came into existence partway through the year? Although that could have tax benefits so it probably doesn't work that way.

Two Headed Mule
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Re: Convert to LLC in the middle of 2017?

Post by Two Headed Mule » Tue Dec 27, 2016 8:20 am

You have the basic gist correct -- report operations through the date of the conversion as you normally would (Schedule C); the conversion is treated as a (generally tax-free) contribution of the business assets to the corporation. Operations from that point forward will be reported by the corporation. The real question is why you would want to do this since interposing a separate tax-paying entity is generally not advised.

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boglerocks
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Re: Convert to LLC in the middle of 2017?

Post by boglerocks » Tue Dec 27, 2016 3:20 pm

Thanks Mule. I'm planning to talk to my CPA about whether this could be advantageous for me.

Spirit Rider
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Re: Convert to LLC in the middle of 2017?

Post by Spirit Rider » Wed Dec 28, 2016 12:39 am

C-Corporations are seldom advantageous for a single shareholder employee corporation unless you have a specialized business model that requires retaining inventory, assets, and/or cash in the corporation. All profits distributed as dividends will be subject to double taxation.

What is the reason for converting mid-year. I am not familiar with the election rules for a C-Corp. With an S-Corp, the dead line for retroactive election is 3/15, but relief is as commonly granted for late election. So unless you have a specific reason to bifurcate the business year, you might be able to treat the whole year as a corporation.

Two Headed Mule
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Re: Convert to LLC in the middle of 2017?

Post by Two Headed Mule » Wed Dec 28, 2016 8:50 am

A check-the-box election to be a C corporation is effective on the date specified on the form (Form 8832), with the following limitation: you can specify any date 12 months in the future and any date up to 75 days prior to the date on which the election is filed (if you specify a date more than 75 days prior, it is effective on the 75th day prior). See 301.7701-3(b)(3)(iii).

Mule

fishmonger
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Re: Convert to LLC in the middle of 2017?

Post by fishmonger » Wed Dec 28, 2016 8:55 am

Are you sure you don't mean converting to an LLC, with an S corp election? Unless there's something I'm missing, it would make very little sense to change your current tax structure to a C corp.

Being an LLC for legal purposes, while electing to be taxed as an S corp is common

boglerocks
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Re: Convert to LLC in the middle of 2017?

Post by boglerocks » Wed Dec 28, 2016 7:43 pm

Taxation as a C corp should allow me better control over when I personally realize business income so that I can minimize my tax liability. I'm not clear on how much exerted control is too much as far as the IRS is concerned. I don't want to push the envelope so I'm planning to ask my CPA.

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Re: Convert to LLC in the middle of 2017?

Post by abuss368 » Wed Dec 28, 2016 9:00 pm

This is a complex tax planning question. I would consider the services of a CPA. With a C Corporation however, you will pay tax at the entity level and also on any dividends you pay. Thus the "double taxation".
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boglerocks
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Re: Convert to LLC in the middle of 2017?

Post by boglerocks » Thu Dec 29, 2016 8:01 am

Dividends are taxed at 0% if you're in the 15% tax bracket.

fishmonger
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Re: Convert to LLC in the middle of 2017?

Post by fishmonger » Thu Dec 29, 2016 8:46 am

boglerocks wrote:Dividends are taxed at 0% if you're in the 15% tax bracket.


You're still getting taxed twice on those profits. It may depend on the state you operate in, but in a single member LLC, those profits are taxed once. When you distribute them, or take a draw, that money isn't taxed again.

I'm not sure how profitable this enterprise is, but the C corp tax brackets are prohibitive. Income over $75k is taxed at 34%; over $100k is taxed at 39%. If you're a one man show, why would you choose to pay tax at that rate?

Again, a lot of details missing but it seems foolish to maneuver to pay very little personal income tax, but get whacked at the corporate level

boglerocks
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Re: Convert to LLC in the middle of 2017?

Post by boglerocks » Thu Dec 29, 2016 9:23 am

Any profits paid to me in the form of salary or bonus are not taxed at the corporate level. Ideally I would be able to realize profits in that form when it is advantageous to do so and not realize those profits in other situations such as when I realize long-term capital gains. Profits left in the company could be realized later in the form of dividends taxed at 0%. But I need to ask my CPA about all of this.

fishmonger
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Re: Convert to LLC in the middle of 2017?

Post by fishmonger » Thu Dec 29, 2016 9:35 am

boglerocks wrote:Any profits paid to me in the form of salary or bonus are not taxed at the corporate level. Ideally I would be able to realize profits in that form when it is advantageous to do so and not realize those profits in other situations such as when I realize long-term capital gains. Profits left in the company could be realized later in the form of dividends taxed at 0%. But I need to ask my CPA about all of this.


I think you're missing the point that the "profits" in the C corp are going to be taxed at an obscene level. And dividends are not deductible on the corporate side, they are merely a distribution of earnings.

C corps in general are a dinosaur entity that are only used in very specific situations. But a qualified CPA should be able to help you

boglerocks
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Re: Convert to LLC in the middle of 2017?

Post by boglerocks » Thu Dec 29, 2016 9:43 am

The point is to gain flexibility. If I don't want to be taxed at obscene corporate levels then I can realize all of the company's profits in the form of salary and bonuses and the corporation will not be taxed at all.

oktax
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Re: Convert to LLC in the middle of 2017?

Post by oktax » Thu Dec 29, 2016 5:10 pm

That's not necessarily true. As a shareholder/employee, you can only pay yourself reasonable compensation. And the IRS enjoys challenging structures where business owners are doing what you're suggesting to avoid paying tax.

I'd suggest reconsidering electing to be taxed as a C Corp. You can get the benefits of limited liability by forming the LLC and allowing it to be taxed by default as a sole proprietorship. Or if you're so inclined, you can potentially save on employment taxes by electing to be taxed as an S Corp. But a C Corp. would almost never make sense.

boglerocks
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Re: Convert to LLC in the middle of 2017?

Post by boglerocks » Fri Dec 30, 2016 5:54 am

That's what I need to ask my CPA about. I want to understand how much control it is permissible to exert over when business income is realized personally from a C corp. It's likely that I don't go the C corp route but I want to make an informed decision.

TerryDMillerMBA
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Re: Convert to LLC in the middle of 2017?

Post by TerryDMillerMBA » Fri Dec 30, 2016 7:21 am

boglerocks wrote:...I want to make an informed decision.


My professional opinion = don't do it. :|

The mid-year election is something I didn't do myself, and ALWAYS counsel against, unless there is some specific, urgent need that only can be met this way.

Taxing the LLC as a C-Corporation may be killing a gnat with a sledgehammer in your case.

boglerocks
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Re: Convert to LLC in the middle of 2017?

Post by boglerocks » Fri Dec 30, 2016 10:57 am

It does feel like overkill. Can I convert the sole prop to an LLC now and elect for C corp tax treatment at some point down the road?

fishmonger
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Re: Convert to LLC in the middle of 2017?

Post by fishmonger » Fri Dec 30, 2016 11:05 am

You keep saying "convert the sole prop to an LLC". It's a single member correct (you don't have other partners or owners)?

A single member LLC is what the IRS calls a "disregarded entity" - you can have the LLC for liability purposes. But for federal tax purposes, you will be report results on Schedule C of your 1040, i.e. you will not have a separate 1065, or Partnership, tax filing.

What is your desire to elect for C corp treatment? As myself and other posters have stated, it makes no sense in 99% of situations. Generally the major reasons people choose to be a C corp is to be able to deduct significant fringe benefits (if you and/or a family member had serious, ongoing medical needs), or you are an entity that will expand signficantly and you want to add numerous other owners in the form of being able to offer shares. There can be other reasons, but it is exceedingly rare

oktax
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Re: Convert to LLC in the middle of 2017?

Post by oktax » Fri Dec 30, 2016 11:16 am

You can form the LLC at any point during the year. Because single member LLCs are disregarded entities by default, forming the LLC will have no tax consequences to you.

You can check the box to elect out of the default tax treatment at any point in the future. You make this election by filing a form with the IRS.

Forming the LLC makes sense for non-tax reasons. Electing out of the default tax classification does not make sense unless you have very specific reasons for doing it. Cheers.

boglerocks
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Re: Convert to LLC in the middle of 2017?

Post by boglerocks » Sat Dec 31, 2016 9:45 am

oktax, thank you for that info.

I saw on the news last night that the Trump administration will propose to change the top tax bracket for corporations to 20% from 35%. If that comes to pass, every small business owner like me would benefit from a SMLLC with C Corp election for the reasons I've outlined.

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