In this article, we’ll assume that you’re a business owner with an LLC, and that you both own and operate your business. If this doesn’t describe you, reach out to us for tailored advice. We’ll also assume you’ve already read our article, “When to Turn Your LLC Into an S Corp.”
The first thing to understand about this process is that, if your LLC were a car, you’re not taking it to the dealership to trade it in; you’re taking it to the body shop for a new coat of paint and an upgraded interior. That is to say, your LLC doesn’t go away when you begin operating as an S Corp—it gets modified.
Here’s how we do it:
1. Benchmark a Reasonable Salary
Until now, you’ve probably been paying yourself by transferring whatever is left in the business bank account to your personal account once the bills are paid. In an LLC, that’s fine.
In an S Corp, however, owners who work in the business are required to be paid a reasonable salary. What is reasonable?
We conduct a fair market compensation analysis for roles with responsibilities similar to yours and present you with a range. Based on your judgment and circumstances, you’ll select a number from within that range, and this becomes your salary.
Anything you earn beyond your salary can be taken out of the business as a distribution, typically on a quarterly basis.
2. Prepare the Business Finances
If you haven’t been processing payroll before, you’ll need to get ready to do so.
We advise all of our clients to create a bank account dedicated solely to payroll and fund it with an amount equal to six months of payroll expenses. Often, businesses need to plan and budget for this a quarter or two before the S Corp goes into effect. We’ll also set up a payroll provider (Gusto is our favorite).
You might be wondering, isn’t six months of funding overkill? But remember that every pay period you’re not just paying yourself—you’re also sending funds to state and federal agencies, insurance providers, and others. If there’s a delay in those payments, all of these entities are going to get very grumpy. If there’s a disruption, it could even jeopardize your S Corp status.
3. File the Paperwork
This is actually one of the simplest steps in the process.
Your tax preparer will file the necessary forms with the IRS. For companies operating on a standard calendar year, the deadline is March 15.
Some states have additional requirements for S Corps, so we’ll handle any required state filings at the same time.
4. Update Your Company Documentation
If you’re the sole owner of your business, you don’t need to do anything.
If ownership of your business is shared, however, you’ll want to review and revise your Operating Agreement to reflect the changes in ownership and compensation structures that come with S Corp tax treatment.
Closing Thoughts
Converting to an S Corp is an important milestone in the growth of a business. It demonstrates that you’ve built a solid foundation of clients and reached a point where you’re not just freelancing—you’re running a company. As part of that, it also introduces new requirements for systematization, organization, and reporting. As your business continues to grow, whether by adding employees or expanding into new territories, these requirements will grow too. One of the hardest parts of this stage is learning to think differently, but once you do, you’ll transition from operating your business to truly owning it.
Still have questions? Ask away. We’ll answer.
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