Whether you form your business as an LLC or a Corporation likely depends on the general nature and purpose of the business. But in any line of business, there is always the potential for growth and change, and in some cases it might make sense to convert your business from one type of entity into another. The conversion process can be highly complex and will involve a number of legal and tax issues, so working with a lawyer is highly recommended. But, to help you get started with the process, this post will help you understand the basics of how to convert an LLC to a C-corporation.
How to Convert an LLC to a C-corporation
The actual process of converting an LLC to a C-corporation can be very complicated. It is highly advisable to work with a lawyer throughout the process to ensure everything is done properly.
There are several major variables that will impact what options you have available, and what the tax implications might be. Those variables include your LLC’s tax status, as well as the method of conversion that you choose to use. Below is a simplified 3 step explanation of the basic process you will need to go through to convert an LLC to a C-corporation.
Step 1: Understand Your Tax Status
When you form an LLC, you have to elect your tax status. Which tax status your LLC falls under will have major implications on what type of conversion you should perform and what the tax implications will be. So the first step in how to convert an LLC to a C-corporation is to determine your tax status.
There are 3 different tax statuses for LLCs:
- LLC taxed as a corporation
- LLC taxed as a partnership
- LLC taxed as a disregarded entity
By default, a multimember LLC (i.e. more than one owner) is taxed as a partnership, and a single member LLC (i.e. only one owner) is taxed as a disregarded entity. In some circumstances, such as where the company will not be distributing profits out to the LLC members, it might make sense to elect to be taxed as a corporation and pay the lower corporate income tax rates. Generally this is not as common as either of the other two scenarios, however.
Which of these 3 tax statuses you fall into will be a key factor in how you convert an LLC to a C-corporation. Since the most common situation involves LLCs taxed as partnerships, the rest of the post will focus mainly on this type of conversion.
Step 2: Choose from Three Conversion Methods
The actual paperwork and process involved in converting an LLC to a C-corporation varies significantly from one state to the next. It’s important to handle everything according to your own state’s laws, which is why it is helpful to hire a business lawyer. Here are the 3 primary conversion methods.
A statutory conversion is a fairly new way of making the conversion from LLC to C-corp. It is often an easier and more streamlined approach, but it’s not a possibility in every state. The basic process of performing a statutory conversion involves filing some specific forms with your Secretary of State’s office. You will also likely have to draft a conversion plan and have it approved by all the members of the LLC.
A statutory conversion is an actual process of law where the LLC “magically” converts into a C-corporation, with the LLC members becoming stockholders, and all of the assets and liabilities of the old LLC automatically becoming assets and liabilities of the corporation. Because no formal assignment agreements are required for this to take effect, a statutory conversion is often the least expensive and easiest method for converting an LLC to a C-corporation.
A statutory merger is a more formal process than the statutory conversion. The basic process involves creating a new corporation and merging the old LLC into it by filing a certificate of merger with the Secretary of State.
When the merger occurs, all of the LLC membership interests are automatically exchanged for stock in the newly formed corporation by process of law, just like a statutory conversion. The company owners have to vote and approve the transaction as both LLC members and shareholders of the C-corp. The old LLC will then have to be dissolved.
Because a statutory merger is more complex and involves a few more steps than a statutory conversion, it is generally more expensive and tedious to complete. But, if your state does not have a statutory conversion process, this will likely be your best option.
The third option is a nonstatutory conversion, which is the most complicated process of the three. In a nonstatutory conversion, all the membership interests, assets, and liabilities have to be formally assigned from the LLC to the newly formed corporation by way of specific legal agreements. Nothing happens automatically or “magically” by process of law like in the previous two methods.
A nonstatutory conversion is very complex and will certainly require legal help from an experienced lawyer. In most situations and states, you will be able to avoid a nonstatutory conversion by using one of the other methods. If for some reason you cannot, you should find a lawyer before beginning the process.
Step 3: Set Up the New Corporation
The conversion process described in step 2 is by far the most difficult step of the three. Once it is complete, you just have to make sure everything in the new corporation is set up properly so you can proceed conducting business as usual.
The main things you will need to take care of include the following:
- Filing articles of organization or incorporation with the Secretary of State
- Getting a new EIN (Employer Identification Number)
- Drafting and adopting corporate bylaws
- Electing officers and directors to manage the corporation
- Holding initial board and shareholder meetings
- Issuing stock certificates
Once you have determined that converting to a C-corporation is the right move for your business, the basic process you will need to go through is as follows:
- Understand your tax status and the implications of it
- Choose a conversion method: either statutory conversion, statutory merger, or nonstatutory conversion
- Set up the newly created corporation and get back to business
If all the legal speak has you feeling overwhelmed, don’t be ashamed. Converting an LLC to a C-corporation is no easy task, and it should not be taken lightly. While it may cost you financially, hiring a lawyer to help you with the process will save you from a bunch of major headaches and make the process much easier and smoother. Definitely a good trade-off if you ask me.
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