LLC Tax Election

February 25, 2023

by a searcher from The University of Chicago - Booth School of Business in New York, NY, USA

Hi all, first time business acquirer here and have a specific question about LLC's tax election. I am thinking about buying an online business with a large seller financing note paid across 3 years.

I understand many people favor an LLC electing to be taxed as S-corp to avoid double taxation. However in this case because I will have to be using most of the profits in first 3 yrs to pay down seller debt instead of distributing any cash flow to myself, wouldn't it make more sense to elect the LLC as C-corp for tax purposes and benefit from lower corporate tax rate (21%) on pre-tax income so I can pay down the debt faster, then later convert to a S-corp tax election when it comes the time to take distribution from the business?

Any advice is greatly appreciated!

Reply by an intermediary
from The University of Chicago in Chicago, IL, USA

Not a tax expert but I have not seen buyers use this approach. When you convert C to S, you have to record built-in-gain (BIG). In order to gain S benefit of single taxation upon exit, a) you have to remain under S for at least, I think, 5 years, and pay double tax on the BIG. If you exit before the 5 years, then you will be taxed as if you are a C Corp.
Further, make sure banks will allow for 3-yr seller note.

Reply by a professional
from Seton Hall University in Morristown, NJ 07960, USA

Hi Angie! I think your thought process is correct, but you just want to be sure that you are careful about passive income levels once you make the S Corporation election in the scenario you describe. That could make the S Corporation a taxable entity. Happy to speak with you about it if you would like. DM me anytime. Rich V.

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