Posted by The TaxAdvocate Group, LLC

Conversion of a C corporation to an LLC

Conversion of a C corporation to an LLC

Owners of small businesses want to change their C corporation to a limited liability company or LLC to be able to avoid double taxation while keeping personal assets safe from business liabilities. An LLC gives the business earnings directly to the member-owners, only when personal income taxes are filed is when the taxes are paid. Moreover, an LLC is provided with the same legal protection as of the corporations but corporate minutes are not required to be kept.

  • Be acquainted with your state’s laws administering business structure conversion. Every state has a different process in changing the legal structure of a business, but usually, most of the states do not allow C corporations to be restructured as an LLC. This means that the C corporation must be closed for the new LLC to be formed.
  • Tax implications must be determined. Transferring business equipment and retaining earnings from a C corporation to an LLC can have an adverse tax effect and it can be costly. To add, Internal Revenue Services must be consulted as well as your state’s department of revenue for you to be aware of the legal and tax consequences in having your C corporation converted to an LLC. You can also consult a tax attorney or an accountant for consultations.
  • Establish an LLC. Employ an attorney to compose the LLC’s articles of organization or make use Legal Zoom or We the People, an online legal-document production services. Encompassed in the articles of organization is the purpose of the LLC, the type of the LLC, its managerial structure, and the authorized people who are responsible for receiving all legal documents for the LLC. The articles are then filed with the secretary of the state’s office and get a filing certificate.
  • Produce the LLC’s operating agreement. LLC operating agreement contains the names and the percentage of ownership of each member is receiving. This agreement states each member’s title and role in the LLC. Employ an attorney to compose the LLC’s operating agreement or make use of the online legal document service. The LLC’s operating agreement is unlike the articles or organizations that need to be filed with the state. Get in touch with the secretary of state’s office to verify if a filing is a requirement.
  • Close the C corporation. A corporation’s articles of dissolution are to be prepared and filed with the state. This document closes the C corporation officially allowing assets to be distributed to the owners and transferring the assets to the newly formed LLC.

Tip

It is best to communicate with the IRS to verify if it is required for the new LLC to have a new employer identification number or if you can use and transfer the C corporation’s EIN to the newly formed LLC.

Important Tax Considerations

Converting to LLC your C corporation taxed as partnership usually causes a high tax bill. This is basically due to the corporation is taxed in concurrence with the transfer of its assets (“liquidation”) or sale, also, the shareholders are taxed based on the distributed assets to them. This means that there is double taxation. Although there may be special situations that will significantly lessen the taxes involved in this conversion type, for instance, the corporation with no appreciation of assets or built-in gain, or suffering from net operating losses (“NOLs”) that can balance gains on its assets distribution during liquidation, in most cases the taxes will compensate to some extent potential advantages of conversion.

A corporation converted to an LLC that will still be taxed as a corporation usually does not have the same level of unfavorable tax penalties as when converting to an LLC taxed as a partnership. This type of conversion is being looked into by the IRS in one of two ways: as a straight trading of stocks for LLC membership that falls under the Internal Revenue Code or the IRC Section 1036, or, in certain instances, as a largely tax-free “F reorganization” a deal falling under IRC § 368(a)(1)(F). Nonetheless, although the tax bill may be lesser, how the bill is being computed are not mainly straightforward, for the most part for an F reorganization. Similarly, as this conversion type will not change the essential components of how a business is being taxed going forward, a close investigation on how it would assist the business, other than by offering a more open management structure.

A C corporation converted to an LLC that has a tax status of “disregarded entity” may perhaps involve such variations as:

  • A corporation converted to an LLC with a single owner
  • A subsidiary corporation of a parent corporation converted into an LLC; or
  • A corporation merged into a disregarded-entity LLC that is owned solely by the parent holding corporation.

The second and third of these variations may look rather exotic for many small businesses. Every variation has its own specific tax consequences. The first variation, which may be most applicable to smaller businesses, will be handled as a liquidation of the corporation by the IRS, with the standard related taxes.

S corporation conversion to an LLC is high different from converting a c corporation to an LLC since the level of taxation of an S corporation is only one; as a rule, tax is paid by the shareholders and not by the S corporation itself. Thus, the tax penalty for this conversion type is often more regulated than c corporation conversions. Since both the LLC and the S corporation have gone through taxation, careful examination of the advantages you may get from this kind of conversion is essential.

As a whole, the tax penalties associated with corporation conversion to LLC is very complicated. Eventually, however, for the corporation-to-LLC conversion of any kind, consult a proficient tax adviser.

The TaxAdvocate Group, LLC
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