You can convert your S Corporation to a Limited Liability Company (LLC) in Delaware at any time. However, there will be tax consequences and other implications of converting an S corporation to an LLC. Let’s discuss what they are and how to convert an S corp to an LLC.
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How to Convert an S Corporation to an LLC in Delaware
Not all conversions are the same. Some states allow direct conversion of an S corp to an LLC, while for the others, you have to look for the other options. Moreover, the company’s circumstances should also be considered while deciding on the method of conversion. You can convert an S corp to LLC using the three methods described below.
In statutory conversion, the S corp files a few forms with the Delaware Secretary of state’s office for conversion into LLC. It is a relatively new and comparatively streamlined procedure. Many states allow statutory conversion, but each state has its own rules and specific forms.
Generally, the following steps for a statutory conversion are common in all states:
- Get conversion approval from the S corporation directors and prepare a plan of conversion
- Put the S corporation conversion approval and the plan of conversion in front of stockholders for voting
- The majority of stockholders must vote in favor of conversion
- File a certificate of conversion and other required documents with the Secretary of state.
- In many states, the S corporation is also required to file LLC certificates of formation
- In the states that require you to file LLC articles of organization, you also need to decide how the LLC will be managed and prepare your LLC’s bylaws or operating agreement.
The state of Delaware allows corporations to convert to Delaware LLCs by statutory conversion. You need to file form LLC-1A with the state while following the steps mentioned above for statutory conversion.
After Statutory Conversion
After the statutory conversion, your corporation ceases to exist. Now the corporate stockholders will be LLC members, and the corporation’s assets and liabilities will automatically be the assets and liabilities of your new LLC.
Benefits of Statutory Conversion
The statutory conversion of an S corporation to an LLC is usually the quickest and most inexpensive way. It saves you from additional formalities and extra filings with the Secretary of state.
The statutory merger is the second option in the states where statutory conversions are not allowed. However, it is more complicated than statutory conversion. Therefore, if your state allows statutory conversion, go for it rather than the statutory merger.
The specific procedure of a statutory merger varies from state to state. However, the following basic steps are usually the same:
- Register a new LLC having all the corporation’s stockholders as LLC members
- Take approval via voting from corporation stockholders about the merger and their roles as LLC members plus as corporate stockholders
- The stockholders must formally exchange their corporation’s shares for LLC membership rights
- File a certificate of merger of the corporation with an LLC with other legally-required documents with the Secretary of state.
Conversion of an S corp into an Arizona LLC is not allowed under Arizona law. So your S corporation can merge with or into a newly formed LLC in Arizona rather than directly converting to an LLC.
After Statutory Merger
After the statutory merger, your corporation’s assets and liabilities will be automatically transferred to the new LLC.
Consequences of Statutory Merger
Unlike statutory conversion, a statutory merger requires you to create a new LLC as a separate business entity before the asset and liability transfer, and it involves multiple steps and fees.
Moreover, you are required to formally exchange corporate shares through a merger agreement for membership rights. In addition to that, you may have to officially dissolve your corporation by filing termination documents with the states.
It is the most complicated and expensive method to convert an S corporation to an LLC. The state-specific procedure for non-statutory conversion may differ slightly. However, the main steps of non-statutory conversion are the same, which are given below:
- Create a new LLC
- Transfer the corporation’s assets and liabilities formally to the newly formed LLC
- Formally exchange S corporation’s shares for newly formed LLC membership interests
- If you have not exchanged S corporation’s shares for LLC membership interests, you must formally liquidate the corporation and file termination papers with the Secretary of state to dissolve the corporation
Statutory conversion of an S corp into an LLC is not allowed in many states. For instance, in Alaska, if your S corporation wants to be converted into an LLC, you have to look for statutory conversion alternatives. You can either merge or choose non-statutory conversion to convert your S corp into Alaska LLC.
After Non-Statutory Conversion
After the non-statutory conversion, your corporation’s assets and liabilities will not be automatically transferred to the new LLC. You will need special agreements to exchange shares of your S corporation for LLC membership interests and to transfer assets and liabilities to LLC.
Consequences of Statutory Merger
The non-statutory conversion is the most complex and expensive way to convert an S corporation into an LLC. You need to file multiple papers and prepare additional agreements for this conversion.
Tax Consequences of Converting an S corporation to an LLC
Since S Corp and an LLC are taxed as pass-through or disregarded entities, there are no significant tax consequences of converting an S corp to an LLC. For more details, please look at Letter Ruling 200528021 issued by the IRS.
This letter explains the tax options after the S corp conversion to LLC, how to file an election to retain S corp’s tax treatment as a corporation, and how to hold onto its S status after the conversion.
FAQs on Converting an S corp into an LLC
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