South Florida Estate Planning: Protecting Your Business: S Corporation Conversion to a Limited Liability Company
Use of an S corporation as an operating business entity has been a common practice given certain tax advantages over operation as a C corporation or an limited liability company ("LLC") taxed as a partnership. Namely, use of an S corporation avoids the double taxation of a C corporation and can provide savings with respect to self-employment taxes when compared to an LLC taxed as a partnership, as income from an LLC is subject to self-employment tax. However, operating as an S corporation can have downsides from a wealth preservation perspective.
Stock in an S corporation or a C corporation is freely attachable by a shareholder's judgment creditor. If you own your business as an S corporation and you are personally sued outside of the business (for example, if you signed a personal guarantee on real estate which is foreclosed with a resulting deficiency judgment), your creditor can foreclose the stock you own in your S corporation to satisfy the judgment. Once the creditor has your stock, they can begin voting and, depending on the amount of stock they possess, they may even be able to gain control of your S corporation and force the sale of assets or liquidation of the entity. For purposes of wealth preservation, this is a terrible result.
The membership interest in a multiple-member LLC cannot be levied by a creditor nor can the creditor levy on the assets owned by the LLC. Instead, the creditor is limited to a "charging lien" on the debtor's membership interest. The creditor will only be entitled to receive distributions made to the debtor member, but cannot compel such distributions, vote the member's interest or control the business operations of the LLC in any way. If the debtor member controls the distributions from the LLC, many times the charging lien will be worthless to a creditor.
Based upon the foregoing, conversion of an existing S corporation to a multi-member LLC for state law purposes is preferable. However, when doing so, adverse tax ramifications need to be addressed in order to avoid a deemed sale of the assets within the S corporation and associated potential taxable gains. The conversion can be treated as a tax-free F-reorganization under §368(a)(1)(F) if the conversion constitutes a "mere change in identity, form or place or organization of one corporation, however effected." Thus, if the conversion is done properly and the ownership does not change, the existing S corporation can be converted to an LLC, thereby deriving all of the asset protection benefits; at the same time, the LLC can continue to be taxed as an S corporation, thereby avoiding a deemed sale of assets with associated potential taxable gains and can continue the tax advantages regarding self-employment tax minimization. For state law purposes, the conversion is deemed to have occurred on the date of the formation of the original S Corporation. However, care must be taken to comply with §601.1112, the Florida conversion statute, as well as timely filing Form 8832 to tax the new LLC as an S corporation.
The converted S corporation will for all purposes be the same entity that existed prior to the conversion; the new LLC will be liable for all the existing liabilities of the converting S corporation and title of all assets will remain vested in the new LLC. As the new LLC will be treated as the same entity and title to real property remains vested in the new LLC, if there is any real estate with existing mortgages, the conversion can be argued not to violate such mortgages' due on sale clauses. Additionally, in Revenue Ruling 73-526, the IRS ruled that the taxpayer identification number of the original S-corporation would be continued by the surviving corporation, further facilitating the ease of conversion.
Care should be used in exercising this conversation, particularly with the S-corporation rules and regulations. If you have an existing S corporation which you would like to convert to an LLC, please contact our South Florida Attorney office for further information.
Stock in an S corporation or a C corporation is freely attachable by a shareholder's judgment creditor. If you own your business as an S corporation and you are personally sued outside of the business (for example, if you signed a personal guarantee on real estate which is foreclosed with a resulting deficiency judgment), your creditor can foreclose the stock you own in your S corporation to satisfy the judgment. Once the creditor has your stock, they can begin voting and, depending on the amount of stock they possess, they may even be able to gain control of your S corporation and force the sale of assets or liquidation of the entity. For purposes of wealth preservation, this is a terrible result.
The membership interest in a multiple-member LLC cannot be levied by a creditor nor can the creditor levy on the assets owned by the LLC. Instead, the creditor is limited to a "charging lien" on the debtor's membership interest. The creditor will only be entitled to receive distributions made to the debtor member, but cannot compel such distributions, vote the member's interest or control the business operations of the LLC in any way. If the debtor member controls the distributions from the LLC, many times the charging lien will be worthless to a creditor.
Based upon the foregoing, conversion of an existing S corporation to a multi-member LLC for state law purposes is preferable. However, when doing so, adverse tax ramifications need to be addressed in order to avoid a deemed sale of the assets within the S corporation and associated potential taxable gains. The conversion can be treated as a tax-free F-reorganization under §368(a)(1)(F) if the conversion constitutes a "mere change in identity, form or place or organization of one corporation, however effected." Thus, if the conversion is done properly and the ownership does not change, the existing S corporation can be converted to an LLC, thereby deriving all of the asset protection benefits; at the same time, the LLC can continue to be taxed as an S corporation, thereby avoiding a deemed sale of assets with associated potential taxable gains and can continue the tax advantages regarding self-employment tax minimization. For state law purposes, the conversion is deemed to have occurred on the date of the formation of the original S Corporation. However, care must be taken to comply with §601.1112, the Florida conversion statute, as well as timely filing Form 8832 to tax the new LLC as an S corporation.
The converted S corporation will for all purposes be the same entity that existed prior to the conversion; the new LLC will be liable for all the existing liabilities of the converting S corporation and title of all assets will remain vested in the new LLC. As the new LLC will be treated as the same entity and title to real property remains vested in the new LLC, if there is any real estate with existing mortgages, the conversion can be argued not to violate such mortgages' due on sale clauses. Additionally, in Revenue Ruling 73-526, the IRS ruled that the taxpayer identification number of the original S-corporation would be continued by the surviving corporation, further facilitating the ease of conversion.
Care should be used in exercising this conversation, particularly with the S-corporation rules and regulations. If you have an existing S corporation which you would like to convert to an LLC, please contact our South Florida Attorney office for further information.
Labels: Florida Asset Protection, Florida Estate Planning, Florida Tax Planning, Florida Wealth Preservation
posted by Noah Davis at
11:40 AM
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