Sometimes it becomes necessary or advisable for a business owner to cease operating as a California LLC (California Limited Liability Company) and commence operating as a California S-Corp. The decision to transfer operations from a California LLC to a California S-Corp may be driven by tax consequences and certain benefits such as personal liability protections, the separation of personal and corporate assets, avoiding double taxation by paying taxes on business income on the same tax return used to pay personal income tax, the ability bifurcate income to reduce self-employment tax liability on self-employment taxes on all net income and instead pay payroll taxes on business income paid as salary to realize significant tax savings, enhance credibility, or maximize certain other limited liability or tax benefits and tax deductible business expenses. In the case of a business or business owner moving, it may also be beneficial to not operate a foreign entity in California, and instead use a statutory conversion to transition into a domestic entity.

While conversion from a California LLC to a California S-Corp is often a solid choice when deciding how to make the business entity transition, conversion is not always the best solution. Sometimes dissolving and winding up the California LLCs and forming new S-Corps is a better solution. As always, consulting with a tax professional regarding tax law is advisable when planning any corporate conversion.

Business owners should understand the essentials and implications of conversion from a California LLC to a California S-Corp, when it is the best choice for transitioning, and when dissolving and winding up a California LLC and forming a new S-Corp is the better choice.

This article will examine a few examples of when conversion is not always the best option.

The Cost of Conversion of a California LLC to a California S-Corp is Generally Higher than Dissolving a California LLC and Forming a New California S-Corp

When considering a transition from a California LLC to a California S-Corp, one of the most significant factors to evaluate is the financial aspect of the conversion process. While it may initially appear convenient to convert an existing California LLC into a California S-Corp, the reality is that this route can be more costly than simply dissolving and winding up the existing California LLC and forming a new California S-Corp.

Initial Filing Fees for Conversion of a California LLC to a California S-Corp versus Dissolving a California LLC and Forming a New California S-Corp

The initial filing fees associated with converting a California LLC to a California S-Corp are more costly than dissolving a California LLC and establishing a new California S-Corp. This section will provide an overview of these costs.

Initial Filing Fees for Conversion of a California LLC to a California S-Corp

The conversion process requires specific filings with the California Secretary of State, which incur various fees. These costs can include Articles of Incorporation with a Statement of Conversion to convert a California LLC into a California S-Corp. The filing fee for Articles of Incorporation with a Statement of Conversion is $150 at the time of this writing.

Initial Filing Fees for Dissolving a California LLC and Forming a New California S-Corp

In contrast, the filing fee for Articles of Incorporation to form a new California S-Corp is $100 at the time of this writing. There is no filing fee to dissolve a California LLC, but certified copies of documents are $5 each at the time of this writing.

Attorneys’ Fees for Conversion of a California LLC to a California S-Corp versus Dissolving a California LLC and Forming a New California S-Corp

Complexity surrounding legal and regulatory requirements for a conversion can lead to higher attorneys’ fees, as the time required to draft documents and execute a conversion from a California LLC to a California S-Corp is greater than the time required to dissolve a California LLC and form a new California S-Corp.

Legal guidance becomes paramount in a conversion process to ensure compliance with relevant laws. Business owners may need to engage legal services to handle the paperwork and navigate the nuances of California’s business laws. Conversely, forming a new California S-Corp after dissolution of a California LLC may involve less legal work, as these procedures are more standardized.

Notice of Exchange Transaction or Entity Conversion Pursuant to California Corporations Code Section 25103(h) Filing Fees for Conversion of a California LLC to a California S-Corp versus Limited Offering Exemption Notice Pursuant to California Corporations Code Section 25102(f) for Dissolving a California LLC and Forming a New California S-Corp

In evaluating the financial implications of converting a California LLC to a California S-Corp, it is crucial to consider the specific filing fees associated with the Notice of Exchange Transaction or Entity Conversion. This section will compare these fees against those required for filing the Limited Offering Exemption Notice when dissolving a California LLC and subsequently forming a new California S-Corp. Understanding these costs will help business owners make informed decisions about their business structure and compliance with California law when migrating from a California LLC to a California S-Corp.

Filing Fees for Notice of Exchange Transaction or Entity Conversion Pursuant to California Corporations Code Section 25103(h)

When converting a California LLC to a California S-Corp, the associated filing fees for the Notice of Exchange Transaction or Entity Conversion as specified in California Corporations Code Section 25103(h) are worth examining. The filing fee for this notice is $600 at the time of this writing, and the complexity of the documentation required necessitates legal assistance from an experienced corporate attorney.

Filing Fees for Limited Offering Exemption Notice Pursuant to California Corporations Code Section 25102(f)

In contrast to the $600 filing fee for a Notice of Exchange Transaction or Entity Conversion, the filing fee for a Limited Offering Exemption Notice pursuant to California Corporations Code Section 25102(f), one of the most commonly used exemption for original issuance of securities in a newly-formed California S-Corp, which vary between $25 for capitalization of up to $25,000, $35 for capitalization of up to $100,000, $50 for capitalizations up to $500,000, $150 for capitalizations up to $1,000,000, and $300 for capitalizations in excess of $1,000,000.

Even the highest Limited Offering Exemption Notice filing fee at $300 is half of the filing fee of the Notice of Exchange Transaction or Entity Conversion filing fee of $600. As most California S-Corps are capitalized at or below $25,000, the Limited Offering Exemption Notice filing fee of $25 is twenty-four times lower than the Notice of Exchange Transaction or Entity Conversion filing fee of $600, which is a significant savings in government filing fees.

Timing and Efficiency of Conversion of a California LLC into a California S-Corp versus Dissolving a California LLC and Forming a New California S-Corp

While not necessarily a direct cost like attorney’s fees and filing fees, when it comes to running a business, time is money. No examination of conversion of a California LLC into a California S-Corp would be complete without examining the timing and efficiency of conversion versus the dissolution of a California LLC and formation of a new California S-Corp.

Timing and Efficiency of Conversion of a California LLC into a California S-Corp

The conversion process from a California LLC to a California S-Corp can be lengthy, potentially taking weeks or months to complete. At the time of this writing, Articles of Incorporation with a Statement of Conversion for converting a California LLC to a California S-Corp may only be filed with the California Secretary of State in paper form. This limitation can impede business operations and cause delays in the continued conduct of business.

Timing and Efficiency of Dissolving a California LLC and Forming a New California S-Corp

In contrast, dissolving an existing California LLC and forming a new California S-Corp is often more streamlined, allowing for a quicker transition and resumption of business activities. In addition, the process of forming a new California S-Corp may be completed online via the website of the California Secretary of State, and with the payment of additional filing fees, a California S-Corp may be formed within twenty-four hours of filing Articles of Incorporation. This allows a business to transition to operating as a California S-Corp in a short amount of time, and potentially operate as a California S-Corp even while the California LLC is still in the process of being dissolved and wound up.

One Caveat to Timing and Efficiency Considerations is Insurance Paneling or other Vendor Relationships

Despite the potential for a more streamlined process in dissolving an existing California LLC and forming a new California S-Corp versus conversion of a California LLC into a California S-Corp, there may be additional considerations that necessitate, or make more attractive, the conversion route.

For example, maintaining business credit, existing loans or lines of credit, or vendor relationships may make it more attractive for a business to maintain continuity of existence through conversion from a California LLC to a California S-Corp rather than dissolution of a California LLC and formation of a new California S-Corp. In these cases, weighing the timing and efficiency factors against any necessary actions to maintain valuable relationships is crucial to consider when choosing how to transition business entities into California S-Corps.

Tax Implications

Converting a California LLC to a California S-Corp may involve both immediate costs and long-term costs, including certain tax implications. Depending on the circumstances, the taxation type of the California LLC and the taxation type of the resulting California S-Corp might have certain consequences with respect to franchise taxes paid to the California Franchise Tax Board, self-employment tax, pass-through income taxation, and double taxation of income. The tax advisors of the business entity and business owner should be consulted prior to making a decision between conversion of a California LLC to a California S-Corp or dissolving a California LLC and forming a new California S-Corp.

Conclusion

In summary, while converting a California LLC to a California S-Corp may be the best choice, it is rarely least expensive choice when weighing filing fees, attorney’s fees, and other associated costs. From initial filing and attorney fees to potential tax implications, business owners contemplating conversion of a California LLC to a California S-Corp versus dissolution of a California LLC and formation of a new California S-Corp should perform (or allow their tax advisors to perform) a thorough cost-benefit analysis to ensure the best method of transitioning from a California LLC to a California S-Corp is chosen.

A Permanent Paper Trail that the California S-Corp Used to be a California LLC

When a California LLC converts to a California S-Corp, the business records of the California LLC remain an integral part of the business records of the California S-Corp. This permanent paper trail can carry significant implications for the newly formed California S-Corp.

Founding Documents of California LLC and California S-Corp

To initiate a conversion from a California LLC to a California S-Corp, the California Secretary of State requires the filing of Articles of Incorporation with a Statement of Conversion. However, the original Articles of Organization of the California LLC do not disappear and should not be discarded. Instead, these documents continue to exist within the business records, reflecting the founding history as a California LLC before conversion to a California S-Corp. This archival process ensures that the California S-Corp maintains a comprehensive record of its business history.

Governing Documents of California LLC and California S-Corp

Maintaining the original Operating Agreement of a California LLC after conversion of the California LLC into a California S-Corp serves several purposes, even after Bylaws adoption by the California S-Corp.

The Operating Agreement of the California LLC helps establish personal liability protection for owners during the time the business structure was a California LLC in the event of disputes between co-owners or third parties, which can be invaluable for providing context and clarity to the business practices prior to conversion and these records may help provide liability protections for disputes that arose from occurrences before the conversion.

Therefore, business owners considering conversion from a California LLC to a California S-Corp must not overlook the significance of the Operating Agreement of their California LLC, as this past will continue to shape the operational landscape of the California S-Corp after conversion.

The EIN of the California LLC May Change Upon Conversion to a California S-Corp

When a California LLC converts to a California S-Corp, one significant administrative change that business owners must consider is the potential requirement to obtain a new Employer Identification Number (EIN) from the Internal Revenue Service (IRS) following conversion.

The EIN, assigned by the IRS, serves as a unique identifier for tax purposes. In the context of converting a California LLC to a California S-Corp, the EIN may need to be changed due to the transformation of the business structure if the taxation type of the California S-Corp after conversion is different than the taxation type of the California LLC prior to conversion.

One of the most common reasons business owners give to the experienced corporate attorneys at San Diego Corporate Law for their reason to elect conversion of a California LLC into a California S-Corp is the desire to maintain their current EIN, so it is important for these business owners to understand when and if maintaining the EIN of a California LLC is possible.

When Must a California S-Corp Obtain a New EIN After Conversion from a California LLC?

An EIN is essential for tax administration and other financial operations, including opening business bank accounts or hiring employees. The IRS has specific rules regarding when a new EIN is required for a business entity that undergoes a structural change.

When a California S-Corp is required to obtain a new EIN upon conversion from a California LLC is rooted in the distinct tax treatments associated with the different entity types. If the taxation type of the newly formed California S-Corp varies from that of the original California LLC (e.g., the California LLC never elected to be taxed as an S Corporation), a new EIN will be required.

When Must a New California S-Corp Obtain a New EIN After Formation?

While it is not always possible to maintain the EIN of a California LLC after conversion to a California S-Corp, the alternative of dissolving and winding up a California LLC and forming a new California S-Corp will always require a new EIN for the new California S-Corp.

Conclusion

The conversion of a California LLC to a California S-Corp may lead to changes in the structure that require a new EIN, however under certain circumstances the EIN of the California LLC may be used by the California S-Corp after conversion. However, when dissolving a California LLC and forming a new California S-Corp, the new California S-Corp will always require a new EIN.

FinCEN Beneficial Ownership Information Report Issues if California LLC to be Converted into a California S-Corp was Formed by an Online Incorporation Service or Non-Responsive Attorney or Accountant

In the process of converting a California LLC into a California S-Corp, particular attention must be paid to the requirements set forth by the Financial Crimes Enforcement Network (FinCEN) regarding the filing of an initial or updated Beneficial Ownership Information Report. If the California LLC was established through an online incorporation service or with the assistance of a now unresponsive attorney or accountant, there may be significant challenges in complying with the FinCEN Beneficial Ownership Information Reporting requirements.

While there should not be an issue with updating Beneficial Ownership Information following conversion from a California LLC to a California S-Corp, unfortunately the experienced corporate attorneys at San Diego Corporate Law have been confronting issues caused by online incorporation services as well as attorneys and accountants who have formed business structures for business owners. This section will explore a few of the potential issues arising from the lack of adequate documentation and professional guidance which can impede the successful conversion and pose risks related to regulatory compliance.

What is FinCEN Beneficial Ownership Information Reporting?

The Financial Crimes Enforcement Network (FinCEN) requires business entities, including California S-Corps, to report beneficial ownership information under the Corporate Transparency Act of 2021.

This federal reporting mandate requires companies to disclose identifying details of individuals who own or control the entity, such as name, home address, date of birth, and unique identifying numbers from, and a copy of, a government-issued identification, driver’s license, or passport.

In addition, business entities formed on or after January 1, 2024, must also disclose the identity of their “Company Applicants” who are persons such as employees of online filing services, attorneys, accountants, and other persons who assisted in the formation of the business entity.

The purpose of this requirement is to enhance transparency and combat money laundering and other illicit financial activities. Compliance with the FinCEN reporting standards is critical, as failure to provide accurate beneficial ownership information can result in substantial penalties and legal repercussions for the entity, including without limitation, civil penalties of up to $500 per day of noncompliance and criminal penalties of up to $10,000 and/or imprisonment for two years.

What Information About a Company Applicant Must be Disclosed in a FinCEN Beneficial Ownership Information Report?

Under the Corporate Transparency Act, business entities are required to disclose specific information regarding their Company Applicants in the FinCEN Beneficial Ownership Information Report. This information includes the full name, residential or business address, date of birth, and unique identifying number from a government-issued identification (such as a driver’s license or passport) of each Company Applicant.

In the alternative, Company Applicants may elect to obtain a unique FinCEN ID, which is a number assigned to a Company Applicant who provides their name, residential or business address, date of birth, and unique identifying number from, and a copy of, a government-issued identification, driver’s license (such as a driver’s license or passport) to FinCEN. This allows a Company Applicant to include their FinCEN ID on Beneficial Ownership Information Reports without providing their address, date of birth, and unique identifying number from, and a copy of, their government issued identification, driver’s license, or passport to their clients.

In addition to not having to provide their address, date of birth, and unique identifying number from, and a copy of, their government issued identification, driver’s license, or passport to their clients, a Company Applicant using a FinCEN ID may update any changes to their reported information one time with their FinCEN ID rather than on hundreds, thousands, and possibly tens or hundreds of thousands of Beneficial Ownership Information Reports on which their information is reported.

The Current Issue with Company Applicant Information from Online Incorporation Services, Non-Responsive Attorneys, and Non-Responsive Accountants

At the time of this writing, less than a year after FinCEN Beneficial Ownership Information Reporting started, the experienced corporate attorneys at San Diego Corporate Law have already encountered significant issues requesting the required Company Applicant information from online incorporation services, non-responsive attorneys, and non-responsive accountants.

Company Applicant Information from Online Incorporation Services

At the time of this writing, most if not all online incorporation services only provide clients with submission receipts for FinCEN Beneficial Ownership Information Reports they filed, but not the transcripts of the actual reports filed. Presumably, this is to protect the personal information of their employees who act as Company Applicants. However, this could be an excuse to make it impossible for a client to file an updated Beneficial Ownership Information Report without the assistance of the online incorporation service.

This is not an issue with one or a few small online incorporation services, this is a uniform issue across all of the major online incorporation services. There is no excuse for these online incorporation services to not have their employees who act as Company Applicants to obtain unique FinCEN IDs and provide filing transcripts to their clients without locking clients in and forcing them to continue only using that specific online incorporation service by depriving clients of information about the formation of their own business entities need to stay in compliance with FinCEN Beneficial Ownership Information Reporting requirements.

Company Applicant Information from Non-Responsive Attorneys and Non-Responsive Accountants

The challenges associated with obtaining Company Applicant information are not limited to online incorporation services; clients also face difficulties when trying to receive necessary data from non-responsive attorneys and non-responsive accountants. Company Applicants play a critical role in the formation and compliance of business entities, and their lack of communication and prompt action can hinder the ability of clients to comply with FinCEN regulations.

Still within the first year of FinCEN Beneficial Ownership Information Reporting, several clients of San Diego Corporate Law have encountered delays or the inability to receive Company Applicant information from non-responsive attorneys and non-responsive accountants who formed business entities for these clients, making it impossible for these clients to comply with FinCEN Beneficial Ownership Information Report requirements. If an attorney or accountant is unwilling to either share their address, date of birth, and unique identifying number from, and a copy of, their government issued identification, driver’s license, or passport with their past and present clients, they should at least be willing to obtain a unique FinCEN ID for use on initial or updated FinCEN Beneficial Ownership Information Reports of their past clients.

The Future Issue with Company Applicant Information Without the Use of a FinCEN ID

As compliance with FinCEN Beneficial Ownership Information Reporting evolves, the absence of a unique FinCEN ID for Company Applicants may lead to escalating complications.

Without providing a unique FinCEN ID to clients, Company Applicants expose their clients to future vulnerability for noncompliance with the strict FinCEN Beneficial Ownership Information Reporting requirements. Even if well intentioned, employees of online services move on to other jobs, attorneys and accountants relocate, retire, become incapacitated, and pass away just like every other human being.

When a Company Applicant fails to use a unique FinCEN ID, or when an online incorporation service, attorney, or accountant who acts as a Company Applicant fails to provide their clients with their unique FinCEN ID, they seriously endanger their clients. The ongoing struggle to obtain timely Company Applicant information underscores the urgency for clients to ensure they are given Beneficial Ownership Information Report transcripts, not just filing receipts, to ensure their ability to comply with FinCEN Beneficial Ownership Information Reporting requirements in the future when employees of online incorporation services, attorneys, and accountants move on to other jobs, relocate, retire, become incapacitated, or pass away.

The Corporate Attorneys at San Diego Corporate Law Use Unique FinCEN IDs as Company Applicants and Always Provide Both a Filing Receipt and Filing Transcript for Every FinCEN Beneficial Ownership Information Report

The corporate attorneys at San Diego Corporate Law distinguish themselves by using unique FinCEN IDs as Company Applicants for each and every FinCEN Beneficial Ownership Information Report. This practice ensures that all relevant information is accurately tracked and easily accessible for compliance purposes.

Furthermore, the attorneys at San Diego Corporate Law provide both a filing receipt and a filing transcript for every FinCEN Beneficial Ownership Information Report submitted. This dual documentation approach not only enhances transparency but also empowers clients with the necessary information to remain compliant with evolving regulatory requirements, reducing the risk of potential noncompliance associated with reliance on third parties.

Conclusion

Converting a California LLC to a California S-Corp is a significant decision that requires careful consideration, particularly regarding the availability of Company Applicant information. Without either the FinCEN ID or address, date of birth, and unique identifying number from, and a copy of, their government issued identification, driver’s license, or passport of the Company Applicant, clients may face substantial compliance challenges after conversion and should consider dissolution of their California LLC and forming a new California S-Corp as the only option.

Therefore, before proceeding with conversion of a California LLC to a California S-Corp, the client should ensure they possess all required Company Applicant information in the form of a unique FinCEN ID for each Company Applicant.

Contact San Diego Corporate Law Before Converting a California LLC to a California S-Corp

Before converting a California LLC to a California Professional Corporation, it is crucial to understand the implications and prerequisites involved in this process. Our experienced team at San Diego Corporate Law is ready to guide you through every step, ensuring you have all necessary information to decide when conversion of a California LLC to a California S-Corp or dissolution of the California LLC and formation of a new California S-Corp is the best choice. Secure your compliance and protect your interests by contacting San Diego Corporate Law—reach out to us today for a consultation today.