Converting from “S” Corporations and Professional Associations (P.A.) to Limited Liability Companies (L.L.C.) and Professional Limited Liability Companies (P.L.)
An “S” Corporation is formed under state law and elects to be taxed under Subchapter S of the Internal Revenue Code by filing IRS Form 2553. In the Past, many small businesses elected to form under Subchapter S as a means to receive Partnership taxation (flow through) while maintaining a corporate veil to protect business owners.
The Problem with the “S” Corp. and P.A.
- Unfortunately, the “S” Corporation structure has been eroded by case law and now provides little to no asset protection against outside personal judgment creditors.
- A judgment creditor could potentially access the “S” Corp. or P.A. as a means to satisfy a personal judgment against a shareholder. Once the judgment creditor takes the stock, the creditor steps into the shoes of the “former” shareholder and acquires the ability to exercise any powers held by him. In many cases, the creditor could force a liquidation of business assets to satisfy the judgment.
Superiority of a L.L.C. or P.L.
- In contrast, a L.L.C. or P.L. business structure would likely prevent an outside personal judgment creditor from accessing the business. As such, they can provide superior asset protection while still providing ‘flow through’ taxation.
- The Florida L.L.C. statutes prohibit an outside personal judgment creditor from levying against the interest of a member, unless otherwise provided in the governing documents of the L.L.C.. A creditor is generally limited to a charging order, giving him only the right to receive capital distributions from the L.L.C.. The catch here is that the members of the L.L.C. will not be required to make a distribution while a lurking judgment creditor exists. In the meantime, the L.L.C. will still be permitted to continue P.A.ying normal operating expenses, including salaries.
- The L.L.C. and P.L., under IRS rulings, also go on the offensive to dissuade a potential judgment creditor. The IRS will attribute the income that flows through the L.L.C. or P.L. to the persons who have the right to receive distributions, regardless of whether the distribution is actually made. Therefore, a creditor may be liable to Pay taxes on undistributed profits.
Effect of Conversion on Existing Business
While the conversion will provide the additional protection as outlined above, the process of converting allows the business to keep:
- The same EIN number (with the IRS)
- The same tax status
- The same ownership
- The same management
We do, however, recommend updating anything that is titled in the name of the original entity to reflect the post-conversion status of the business as an L.L.C. (e.g. business bank account(s), retirement/401k Plans, signage, letterhead, etc…)
Letting a Professional Handle the Conversion
While converting an “S”Corp. or P.A. to a L.L.C. or P.L., is a relatively simple way to provide better asset protection and an increased sense of security, it must be done properly. We highly recommend you look to a Law firm specializing in this area, in order to safeguard against mistakes or oversights that can lead to potentially adverse tax ramifications or disruptions in a business during and after the conversion process.
