Making the decision to change your business structure from a corporation to a Limited Liability Company (LLC) can be a smart strategic move for many companies. While converting a corporation to an LLC may seem complicated, the process is actually straightforward in most states.
Converting a corporation to an LLC can provide tax benefits, operational flexibility, and reduced paperwork for many small businesses. While the conversion process varies by state, it typically involves filing articles of conversion, transferring assets, updating licenses and contracts, and dissolving the old corporation. Business owners should carefully consider the tax implications and weigh the pros and cons before undergoing a corporation to LLC conversion.
In this comprehensive guide, we’ll walk you through everything you need to know to successfully convert your corporation to an LLC, from understanding the key differences between corporations and LLCs, to step-by-step instructions for completing the conversion.
Why You Should Consider Converting Your Corporation to an LLC
There are several compelling reasons why small business owners decide to switch from a corporation structure to an LLC:
One of the biggest appeals of an LLC is the tax flexibility it provides. An LLC is considered a “pass-through entity” for tax purposes, meaning profits and losses pass through to the owners’ personal tax returns. With a traditional C corporation, profits are taxed at both the corporate and personal level. Converting to an LLC can eliminate this double taxation.
LLC‘s provide much more flexibility in structuring ownership and operations compared to corporations. With an LLC you can divvy up ownership, voting rights and profit distributions however you’d like. Corporations have more rigid rules.
LLC‘s have fewer reporting and compliance requirements than corporations, which cuts down on administrative hassles. Corporations must hold shareholder meetings, keep corporate minutes, appoint officers and directors, issue stock certificates, and file annual reports in most states.
Step-by-Step Guide for Converting a Corporation to an LLC
The specific process for converting a corporation to an LLC varies by state. However, there are some general steps every business must take:
1. Review Your State’s Conversion Requirements
The first thing you should do is verify the conversion process and rules for your particular state. Many states have streamlined procedures that allow you to convert simply by filing conversion documents, without needing to create a new LLC or formally transfer assets. Check with your Secretary of State’s office.
2. Consider the Tax Implications
Before converting, consult with a tax advisor to understand the potential tax consequences. In some cases, the IRS may consider this a sale or liquidation of the corporation, triggering capital gains taxes. You want to be aware of this before proceeding.
3. Draft and File Conversion Documents
Most states require you to file Articles of Conversion or a Certificate of Conversion to formally convert your corporation to an LLC. These documents are filed with the Secretary of State and must include certain company information like the new LLC name.
4. Transfer Assets and Liabilities
If required in your state, take the necessary steps to transfer ownership of all corporate assets and responsibility for liabilities to the new LLC. Consult an attorney to ensure this is done properly.
5. Update Business Licenses, Contracts and Bank Accounts
Once the conversion is official, remember to update any vendor accounts, licensing, insurance policies, contracts, bank accounts, etc. to reflect your new LLC. Notify clients of the change.
6. Close Out the Old Corporation
Finally, tie up any loose ends to shut down your old corporation, including filing final tax returns. Most states require you to file Articles of Dissolution to formally dissolve the corporation.
And that’s the basic process for converting your corporation to an LLC! While it may seem daunting, it’s a very common transition for small businesses. Don’t hesitate to consult legal and tax experts to ensure it goes smoothly.
Key Differences Between LLC‘s and Corporations
Before deciding whether to convert your corporation, it’s important to understand some of the major differences between these two business structures:
- Tax Treatment – As mentioned above, LLC‘s are pass-through entities while C corporations face double taxation. However, S corporations also provide pass-through taxation like an LLC.
- Ownership Flexibility – LLC ownership is very flexible, while corporations must issue stock. LLC‘s have no limits on number of owners.
- Management Structure – LLC management is informal with fewer required roles. Corporations must appoint officers and directors.
- Paperwork and Compliance – LLC‘s have minimal reporting and paperwork. Corporations face more stringent requirements.
- Raising Capital – Corporations can raise funds by issuing stock. LLC‘s cannot sell stock and have fewer options.
Pros of Converting a C Corporation to an LLC
Converting a traditional C corporation to an LLC can offer some nice benefits:
- Avoid double taxation of profits
- Gain flexibility over profit/loss distribution
- Eliminate corporate governance formalities
- Reduce state compliance requirements
- Improve liability protection for owners
For these reasons, C corporations are often incentivized to convert to LLC status once they’ve grown beyond the small business stage.
Cons of Converting a Corporation to an LLC
There are also a few potential downsides of converting a corporation to an LLC to consider:
- Tax implications of deemed asset sale upon conversion
- Increased state taxes in some states that tax LLC income
- Loss of ability to attract equity investors through stock sales
- Difficulty transferring ownership interests compared to stock
- Loss of corporate brand identity if name changes
Overall the pros often outweigh the cons, but assess your specific situation carefully. Consult experts to minimize tax impacts.
Alternatives to Converting Your Corporation to an LLC
For some businesses, it may make more sense to keep your corporation but elect S corporation status for tax purposes, rather than undergoing a full conversion. Here are a few options to consider:
- S Corporation Election – File Form 2553 to have your C corp taxed as an S corporation.
- B Corporation Status – Amend your articles to become a benefit corporation.
- Series LLC – Establish separate LLC series within your corporation.
Discuss these alternatives with your tax and legal advisors before deciding on converting to an LLC.
Steps for Converting an S Corporation to an LLC
The process for converting an S corporation to an LLC follows the same general steps as converting a C corporation. While the overall procedure is essentially the same, there are some important differences in terms of the tax implications. The conversion tends to be simpler for S corps and has less significant tax consequences in most cases.
The process for converting an S corporation to an LLC is very similar:
- Review state conversion requirements
- Consider tax consequences carefully
- Draft and file Articles of Conversion
- Transfer assets and liabilities
- Notify state, vendors, clients of LLC status
- Dissolve the S corporation
The tax implications are usually less significant than with a C corporation. Overall it’s a simpler conversion, but still consult a tax pro.
Is Converting a Corporation to an LLC Right for You?
There are many good reasons why small business owners decide to convert their corporation to an LLC. It often makes practical and financial sense. But realize it has many complex legal and tax considerations. Before undergoing a conversion:
- Clearly understand your motivations and expected benefits
- Carefully weigh the pros and cons for your situation
- Consult both a tax advisor and business attorney
- Review your state’s specific conversion process
- Consider alternatives like S corporation status
If done properly, switching from a corporation to a more flexible LLC structure can be very advantageous without much hassle. But make sure you do your homework before making this important business move.
Converting your corporation to an LLC can provide tremendous benefits, especially for small businesses that have outgrown the corporate structure. While the conversion process varies by state, it is generally straightforward. The key is understanding the tax implications and following the proper protocols.
Be sure to thoroughly assess whether switching to an LLC makes sense for your particular business situation. Weigh the pros and cons. And work closely with business attorneys and tax/accounting professionals to ensure your corporation to LLC conversion goes smoothly.
Frequently Asked Questions (FAQs)
What are the steps to convert a corporation to an LLC?
The key steps are: 1) Review state conversion rules, 2) Consider tax impacts, 3) File required conversion documents like Articles of Conversion, 4) Transfer assets/liabilities, 5) Update licenses and accounts for new LLC, and 6) Dissolve the corporation.
Does converting a corporation to an LLC require creating a new company?
In most states you can simply file a conversion document without needing to create a new standalone LLC or transfer assets. However, some states do require setting up a separate LLC.
What are the tax implications of converting a C corporation?
Converting a C corp is usually considered a taxable liquidation event. The corporation pays taxes on asset sales, shareholders pay capital gains taxes, and their stock basis transfers to the new LLC.
Can I convert my S corporation to an LLC?
Yes, S corporations can convert to LLC‘s through the same overall process. The tax implications are often less significant than with a C corporation.
How much does it cost to convert a corporation to an LLC?
The direct state filing fees are typically $100-200. However, additional legal and tax advisory fees can add up to thousands of dollars if extensive professional help is needed.
Lyle Solomon has considerable litigation experience as well as substantial hands-on knowledge and expertise in legal analysis and writing. Since 2003, he has been a member of the State Bar of California. In 1998, he graduated from the University of the Pacific’s McGeorge School of Law in Sacramento, California, and now serves as a principal attorney for the Oak View Law Group in California. He has contributed to publications such as Entrepreneur, All Business, US Chamber, Finance Magnates, Next Avenue, and many more.