United States: Trade Your S Corporation For An LLC

Published in the New Hampshire Business Magazine

Every business owner is looking for ways to save money and make more. In NH, that can be accomplished by converting an S corporation with NH shareholders to a limited liability company (LLC). In summer 2013, the NH Department of Revenue Administration issued a ruling allowing that conversion with no taxes due. Also, if the equity of the resulting LLC is not freely transferable shares, NH owners of the LLC will not owe NH interest and dividends tax on future LLC distributions paid to them.

In NH, businesses face two layers of state income tax: the Business Profits Tax and Business Enterprise Tax, and the Interest and Dividends tax. The Business Profits Tax, set at 8.5 percent of a business's income, applies if annual gross receipts exceed $50,000. The Business Enterprise Tax is set at 0.75 percent of the company's enterprise value tax base, or total compensation paid out, including dividends and interest.

Granite Staters must pay a 5 percent Interest and Dividends (I&D) tax on distributions or dividends paid by corporations (including S corporations) and LLCs. There is one exception: If the equity of an LLC is not freely transferable, then the I&D tax doesn't have to be paid on distributions to the LLC's NH owners. LLC equity is con- sidered not freely transferable ifit cannot be transferred without prior approval from the LLC owners or if transfer causes the LLC to be dissolved. Because of this exception, many NH businesses prefer organizing as an LLC to enjoy a single layer of NH tax.

Adding to an LLC's allure is that federal law imposes only one layer of tax at the owner level on income of S corporations and most LLCs. Federal tax law allows considerable tax-flexibility to LLCs, which are taxed only at the owner level by default, unless it elects to be taxed as a corporation by checking a box on the simple form. Rulings issued by the Internal Revenue Service (IRS) in 2005 and 2008 enhanced this flexibility by permitting S corporations to convert to LLCs without owing tax on conversion so long as there was no change in ownership or economic position of the owners. A simple form is filed with the IRS within 75 days of conversion.

Those IRS rulings created increased interest for S corporations to convert to LLCs in NH to avoid paying the state's I&D tax. But businesses were concerned the NH Department of Revenue Administration would consider these conversions to be tax events, resulting in businesses paying more in Business Profits Tax and Business Enterprise Tax and, for S corporations that own real property, a transfer of real property on which Real Estate Transfer Tax would be payable.

The July 26, 2013 Declaratory Ruling from the Department of Revenue Administration alleviated these concerns. It is now fairly secure that conversion of a NH S corporation to a NH LLC taxed federally as an S corporation will not subject the S corporation, the resulting LLC or the owners to any additional NH taxes.

M.L. Geffert is a member of the Corporate Department at the law firm of McLane, Graf, Raulerson & Middleton, Professional Association.  

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.