Posted by Larry Hurt

C Corp to an LLC: Heres How to Convert

C Corp to an LLC: Heres How to Convert

The details on how to turn your small business from a C Corp to an LLC vary depending on several factors. While we may not be able to see all of the possible scenarios, here are some basic facts about the whole process.

Key variable conversion elements

First, it is vital to know that there is not just one type of company, one tax status of an LLC, or one type of conversion. On the contrary, there are:

  • C Corporations (which pays corporate tax) and S Corps (which have transfer rights, so only shareholders pay taxes)
  • Companies incorporated under the laws of your state and companies incorporated under the laws of other states
  • Multiple member LLC and single-member LLC
  • LLCs imposed as partnerships, LLCs imposed as commercial companies and LLCs imposed as "disregarded entities"; and
  • Different ways to transform your business, including legal conversions, legal mergers, and non-legal conversions.

Given these variables, it is essential to understand that, for example, the conversion of C Corporations into a company taxed as a company by legal merger is fundamentally different, both in terms of the required paperwork and in terms of tax consequences. The necessary documentation of the conversion by an S Corporation into an LLC imposed as a company by a legal conversion. 

Here we will try to simplify things and mainly analyze the C corps and its conversion into an LLC.

Three types of conversions

  • Legal conversion is a relatively new and simplified procedure, available in many states, that allows you to convert your business to LLC, by sending certain forms to the Secretary of State. Each state that allows legal conversions has its specific forms and rules. However, in general terms, the stages of a legal conversion include:
    • Convince company executives to approve the conversion and prepare a conversion plan
    • Ask the directors to approve the conversion and shareholding plan
    • Have the majority of shareholders vote to approve the conversion; and
    • Send a conversion certificate and, if necessary, an LLC training certificate and other required documents to the Secretary of State.

Although there are significant technical differences between a legal conversion and other types of conversion, the practical effects are the same: those who were previously shareholders of the company are now members of the new LLC, the assets, and liabilities of your company are currently active, and the obligations of your new LLC and your C Corporation cease to exist. An important point regarding legal conversions is that all of these effects occur automatically by the policy and not by separate formal agreements on the exchange of shares and transfers of assets and liabilities and without additional registrations to the secretary of state. Legal conversion is usually the quickest and cheapest way to move from a business to an LLC. In the states where it is available, this will often be the best option.

  • A legal merger is more complicated than legal conversion. However, if your state does not allow legal conversions, you can use this method. Although the specific details differ from state to state, the necessary steps for a statutory merger generally include:
    • Form a new LLC (this implies that the shareholders of the company will also be members of the LLC)
    • Get the shareholders' vote of the company to approve the merger, both in their role as shareholders and in LLC members.
    • Encourage shareholders to change their shares for association rights with the LLC formally; and
    • Present a certificate of amalgamation and any other document legally required by the Secretary of State.

As a legal conversion, a legal merger automatically transfers your company's assets and liabilities to the new LLC, per the law. However, unlike the legal conversion, it is necessary to create the new LLC as a separate social entity before the transfer, a process involving several stages and commissions, as well as the formal exchange of shares of the company with the rights of association via a Fusion contract. You may also be expected to submit a form that formally dissolves your business.

  • Non-mandatory conversion is usually the most complicated and costly way to move from an LLC to a business. In short, the main steps are:
    • Form a new LLC
    • Officially transfer your company's assets and liabilities to LLC
    • The formal exchange of company shares with the associative interests of the LLC; and
    • Liquidate and dissolve the company formally, also presenting all the necessary dissolution secrets to the Secretary of State.

Unlike the two previous conversion methods, in the conversion that is not required by law, the assets and liabilities of the business are not automatically transferred to the new LLC. Instead, in combination with the formation of a new LLC, in a non-legal conversion, you will need exclusive agreements to modify the shares of the company with the associative interests of the LLC and transfer the assets and liabilities. There are several ways to manage these transfers and exchanges. If an irregular conversion is required, specialized legal assistance is needed. However, in most cases, you should avoid using this approach.

Important tax considerations

The conversion of C Corporations into a company taxed as a business generally involves a hefty tax invoice. This is for the most part because the company pays taxes as well as the sale or transfer of its assets, and the shareholders also pay taxes on the assets distributed to them. In other words, there is double taxation. 

Although there may be exceptional circumstances that significantly reduce the taxes involved in this type of conversion, such as a company with no incorporated profits or appreciation of assets or with significant net operating losses ("NOL"), which may compensate profits from asset distribution, during liquidation, in many cases, the commissions outweigh the potential benefits of the conversion.

Transforming a business into an LLC that will continue to be taxed as a business generally does not have the same level of disadvantageous tax consequences as when it becomes an LLC taxed as a partnership. The IRS will view this type of conversion in two ways: as a direct exchange of shares by LLC members who fall under section 1036 of the Internal Revenue Code (IRC) or, in some cases, as a "F" reorganization," largely tax-exempt "(ie, a transaction included in IRC § 368 (a) (1) (F)). 

However, although the invoice may be smaller, the details of calculating these invoices are not simple, especially for F reorganization. Also, as this type of conversion does not change the basics of your business's taxation in the future, you should carefully consider the benefits to the business, as well as a weaker and more flexible administrative structure of the conversion of C Corporations into LLC with tax status. 

Converting an S Corp to LLC is fundamentally different from converting a C Corporations since an S Corp has only one level of taxation; as a general rule, S Corps does not pay taxes, but only its shareholders. Consequently, the tax consequences for this type of conversion are generally more limited than the conversions of C Corporations. At the same time, given that a company S and an LLC have transfer fees, it is necessary to examine the expected benefits carefully when you do this type of conversion.

Larry Hurt
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