Changing S Corporation to LLC: Tax Effect Of Merger And Conversion

LLCs provide better asset protection of the owners’ interest than do corporations. Many asset protection plans involve changing a clients’ existing Subchapter S corporations to an LLC taxable as an S corp. There are two ways to do this. One way is to create a new LLC and then file articles of conversion which turn the corporation into the new LLC. The corporation turns into an LLC and all corporation assets automatically transfer to the LLC The other way is to merge the corporation into an existing LLC which already has assets. When the corporation has assets with built-in appreciation the there is an income tax issue with this plan. The issue is whether the change to the corporation accelerates income tax.

This past week one of my clients was considering whether he wanted to convert a corporation to a new LLC or merge the same corporation with an existing LLC. He asked me whether the IRS treats the merger and conversion differently with respect to taxation of built in appreciation in corporation assets. As I am not a tax attorney I had to reach out for the answer.

I consulted with my asset protection CPA, Lonnie Young of Orlando, Florida (407 396 2500). Mr. Young explained that a merger into an LLC or a conversion to an LLC are treated the same for income tax purposes. He said that if the LLC has elected taxation as a sub-S corporation and the ownership of the LLC is  the same as the ownership of the corporation, neither the merger nor the conversion has adverse income tax consequences.

This particular client would have a tax problem with his plan. He owned 100% of his corporation stock, but he wanted a two member LLC for asset protection. Adding the LLC owner would cause a tax issue.