If the owners of your LLC agree, you can convert your company to a corporation. Some states have a streamlined process that allows you to easily transition your LLC to a corporation. In other states, the process is more complex, requiring additional time and paperwork.
Changing your business structure will have consequences, both those that you want and those that aren’t so attractive. Before making the change, review the practical differences between the two business entities, including filing requirements, taxes, and corporate formalities. If you don’t like what you learn, instead of converting to a corporation, you can change the company’s tax status and keep your business organized as an LLC.
Before converting your LLC to a corporation, be sure you understand what you’re getting into with the new structure. First, the similarities between the two: Both LLCs and corporations are entities that are separate from their owners, and they do not exist until the owners file formation paperwork. Unlike sole proprietorships and partnerships, these companies can own assets and take on obligations. Corporations and LLCs each offer limited liability protection, which means that the owners are normally not personally responsible for the debts and obligations of the business.
LLCs offer a more flexible management structure than corporations. The LLC owners (known as “members”) manage the company, or they can bring in a third party to handle the day-to-day operations. Your state might require LLCs to file annual reports, but the content of the reports is limited to basic information like the company address and registered agent.
Managing a corporation is more rule-bound. The formalities include the need to hold regular meetings, create minutes, keep records, and submit annual reports. State law might require that corporate annual reports include detailed information about the corporation and its finances, such as the number of shares and capital investments.
When it comes to taxes, LLCs have attractive options that corporations do not enjoy. By default, LLC owners file and pay taxes as a sole proprietorship (for single and husband-wife owners) or partnerships (for multi-owner companies). However, members can file additional paperwork to elect S Corporation or C Corporation tax status (more below). By contrast, a corporation must pay taxes as a C Corporation or an S Corporation. A C Corporation is subject to “double taxation.” The company pays corporate tax on income that comes into the business, and after distributing the profits, the owners and shareholders pay taxes a second time on the same income on their personal tax returns.
Now that you are familiar with some of the practical consequences of a conversion, think again about whether you really need to become a corporation. Changing the structure of a business to a corporation is beneficial to some enterprises, but it’s not for everyone. If you’re in need of capital, you’ll find that investors often prefer to work with corporations because it is easier to sell shares in a corporation than transfer ownership in an LLC. Creating a corporation gives you the option to issues stock and “go public” with the company, allowing you to grow the company by selling shares to the public.
On the other hand, if you do not plan to bring in investors or go public, the difficulties in converting your LLC and maintaining a corporation are not likely to be worth the effort. It is not necessary to change the structure of your business to grow or increase profits, and you will find many large and successful enterprises that continue to operate as LLCs.
If you’ve decided that conversion to a corporation makes sense for your LLC, here’s what you are in for. The paperwork and process for converting your LLC will depend on the laws of the state where you formed your company. In all states, the LLC members must approve the change and create a plan for conversion, which will detail how member ownership will convert into shares of stock. After conversion, the members become the shareholders of the corporation, and the owners transfer all assets and obligations of the LLC to the corporation. The three options for conversion are:
Statutory Conversion: Some states allow for “statutory” conversion, which refers to a law that creates a streamlined process for changing the business structure. In states that provide this option, you change an LLC to a corporation by filing conversion forms with the Secretary of State. When the Secretary approves your filings, the state dissolves the LLC and transfers debts and obligations to the corporation. You do not file separate paperwork to form the corporation.
Statutory Merger: If your state does not allow for conversions, you might be able to pursue a merger, which is a more complex process. First, you form a new corporation and list your LLC members as shareholders. Afterward, you’ll file a certificate of merger and then file forms to dissolve the LLC. The assets and obligations of the LLC will transfer to the corporation.
Non-statutory merger: Under this option, you do not follow one of the state-created processes. Instead, you form a new corporation, issue corporate shares to LLC members, transfer LLC assets, and then dissolve the LLC. Because you can run into complications when transferring assets and liabilities, it is best to consult with an attorney to pursue a non-statutory merger.
Whether you pursue a conversion or a merger, you must follow the steps for forming a new corporation, including:
Once your corporate conversion is complete, you will have new corporate formalities to follow, including the need to hold regular meetings of directors and shareholders, maintain corporate minutes, and file annual reports with the state.
In many cases, the business will not owe taxes for converting. However, if you transfer more or less than all of the LLC’s assets to the corporation, or if the members of the LLC are not the shareholders of the new corporation, you might be responsible for additional taxes and filings. Consult with an accountant or tax attorney to determine your filing requirements.
Instead of changing your LLC to a corporation, you can file paperwork with the IRS to elect S Corporation or C Corporation tax status. With this option, you would still run your business as an LLC, but you will pay taxes as a corporation. While this will not allow you to issue stock or go public, you can enjoy the benefits of corporate taxation, such as avoiding self-employment tax on a portion of the business profits. Click here too read more about electing corporate tax status.