There are a myriad of factors to consider when deciding whether to form your business as an LLC or a corporation. Many entrepreneurs choose an LLC for its simplicity and streamlined operation. Others prefer corporations for their structure and appeal to investors while raising capital. If you have outgrown your LLC or changed your vision for the business, it might make sense to convert the LLC to a corporation. The process of conversion can be complex and will likely involve a number or legal issues and tax consequences. Working with an experienced attorney and accountant from the very beginning is highly recommended. This blog is intended to provide you a basic understanding of how to convert an LLC to a C-corporation.
The process of converting an LLC to a C-corporation can be complicated depending on your circumstances. I cannot overstate the importance of working through the process with a business attorney to ensure that everything is properly done.
How to convert your LLC to a C-corporation.
There are two variables that will directly impact the conversion options available to you and their tax implications. The first is the tax status of your LLC. The other is the method of conversion that you choose. What follows is an explanation of the process that you will go through to convert your LLC to a C-corporation.
1. Understanding your Tax Status.
When you initially formed the LLC, you were required to elect how the LLC would be taxed (“Tax Status”). The Tax Status of the LLC will have profound implications on the type of conversion that should be performed and the resulting tax implication to the company and its members. So, the first step in the conversion process is to determine your LLC’s Tax Status.
Generally, there are 3 tax statuses that the IRS recognizes for an LLC. An LLC can elect to be taxed as: (1) a disregarded entity; (2) a partnership; or (3) a corporation. By default, the IRS taxes a single member LLC (one owner) as a disregarded entity and a multi-member LLC as a partnership. In some circumstances the LLC can elect to be taxed as a corporation to benefit from a lower income tax rate, but this is not a typical scenario. Since the most common scenario involves taxation as a partnership or disregarded entity, the emphasis of this blog focuses on this type of conversion.
2. Choosing a Method of Conversion.
Once you have determined the Tax Status of your LLC, the next step is to choose the method of conversion. The paperwork and process to convert an LLC to a C-corporation varies widely from state to state. Determining the conversion methods allowed in your state and choosing the best method for your circumstances is another reason to hire a business lawyer to help you. The three most common methods of conversion are explained below.
The process of a statutory merger involves forming a new corporation and merging your LLC into the corporation by filing a certificate of merger with the secretary of state. The owners of the company will need to approve the merger both as members of the LLC and as shareholders of the corporation. Once the merger happens, the LLC interest of each member is automatically exchanged for new stock in the corporation by operation of law. The final part of a statutory merger is to dissolve the LLC.
An alternative method of conversion is statutory conversion. Statutory conversion is generally the least expensive and easiest method of conversion, but is not available in some states. Statutory conversion is a new process of law where an LLC magically converts into a C-corporation. Unlike other methods of conversion, only one business entity is involved. There is a continuation of existence and you do not need to form a separate corporation or dissolve the LLC. The members automatically become shareholders and the assets and liabilities of the LLC automatically become assets and liabilities of the corporation. There are no formal assignment agreements required like other methods of conversion.
If your state permits statutory conversion, like Delaware and Georgia do, it is almost always the preferred method of conversion. Each state that permits statutory conversion has their own forms to file with the secretary of state and will require that the members of the LLC prepare and adopt a plan of conversion.
The most complicated and expensive conversion option is non-statutory conversion. This process entails the formal assignment of membership interests, assets, and liabilities from the LLC to the newly formed corporation through specific legal agreements. There is no automatic or magical conversion by operation of law. Due to the complexity of the legal agreements required to accomplish a non-statutory conversion, the assistance of an experienced business attorney is required. Luckily, in many situations and states, you can avoid non-statutory conversion by using one of the other methods.
Once you have completed the conversion process, there are a few additional matters to consider in order to make sure that the new corporation is set up properly.
1. Drafting and adopting bylaws for the corporation.
2. Electing officers and directors;
3. Holding an initial board meeting and shareholders meeting;
4. Issuing stock certificates;
5. Obtaining a new EIN (taxpayer ID) for the corporation if you elected a statutory merger or non-statutory conversion.
6. Filing articles of incorporation with the secretary of state (typically completed as part of the conversion paperwork).
If the conversion process has you confused or feeling overwhelmed, rest assured that you are not alone. The process of converting an LLC to a C-corporation is neither easy nor straight forward and should never be taken lightly. A good business attorney can demystify the process and save you major financial and logistical headaches by making sure every step of the conversion is completed correctly.
Hight Law, LLC is one of Atlanta’s premiere business law firms focused on business law, start-ups and entrepreneurs, franchises, and business disputes. We can help guide you through the LLC conversion process and ensure that the conversion is a worry free experience.
This article is for general information only. The information presented should not be construed to be formal legal advice nor the formation of a lawyer/client relationship.