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Posted by Jim McClaflin, EA, NTPI Fellow, CTRC

How to Convert a Corporation to an LLC

How to Convert a Corporation to an LLC

The traditional process is slow and tedious if you want to convert your corporation to an LLC. But in many states, there is an easier and less expensive way.

Although it doesn't always happen, it's not uncommon for shareholders to talk about changing the business to an LLC or limited liability company. There are several reasons shareholders might decide that such a change in the corporate structure is beneficial.

Corporation versus LLC

A company name must include "Inc." or "Incorporated" or another indicator that the entity is a corporation. In contrast, the name of an LLC must include "LLC" or another similar indicator indicating that it is a limited liability company. However, there are several differences between the two entities in the style of their names.

A common reason to convert a corporation to an LLC is to avoid double taxation. A corporation usually faces double taxation because it is taxed on the income it earned and then in the hands of its shareholders.

On the other hand, an LLC offers "pass-through taxation" (unless you choose to pay taxes as a corporation); it is a tax-exempt entity, meaning it does not pay taxes on the income it earns. Instead, this income is "passed through" to its members, where it is then taxed.

There are other reasons why the LLC business structure form may be more beneficial than the incorporated form. An LLC provides a more flexible management structure that your company's shareholders may find desirable, and profits don't have to be distributed based on ownership percentages.

In addition, corporations must also adhere to more stringent compliance conditions, such as holding annual meetings and meeting minutes. Although LLCs are often encouraged to do the same, these formalities are not real requirements.

Going from Corporation to LLC: The Traditional Way

Converting a corporation to an LLC is not an impossible task. Still, the traditional way of doing it can be quite complicated and expensive, requiring you to first create a new LLC and then transfer the assets and liabilities of the business to the new LLC, exchange shareholder shares for LLC membership, then dissolve the corporation.

Fortunately, it is possible to transform a corporation into an LLC without going through this more complicated procedure. Consult a tax professional to guide you on how to go about it.

Take a more streamlined approach if your state allows it

If you think there are benefits to converting your business to an LLC, is it possible to do so without dissolving the business?

Many states offer a less complicated and expensive business entity conversion process than the traditional method. Using this conversion process to convert the corporation to an LLC does not require the dissolution of the company.

Instead of forming an LLC, the company becomes an LLC. Additionally, the assets and liabilities of the business are automatically transferred to the new LLC.

However, some states do not offer this lower conversion process. You will need to check with the state trade agency where your business was incorporated to see if a conversion process is available.

During your research, you may find that your state has a merger process rather than a conversion process. Although a merger process is not as complicated as the traditional method of changing your corporation to an LLC (for example, a merger will automatically transfer your business assets and liabilities to the new LLC as well), you will need to do with two separate entities: the new LLC must first be formed just like the corporation, and once it is complete, you will need to dissolve the corporation.

Suppose the state in which your company was incorporated does not offer a business entity conversion process, and you still wish to convert your company to an LLC. In that case, you will have to take the more traditional and expensive route, which involves several formal steps, including winding up your business.

Following the correct steps for conversion

Since each state that offers a corporate entity conversion process will have different requirements, it is beyond the scope of this article to list everything you will need to do; however, in general, you will probably need to do the following:

  • Plan of conversion: Most, but not all, states that have a conversion process require the preparation of a conversion plan. The contents of such a plan will range depending on your state, so it is important to check if such a plan is required. You will need to follow all of the steps in the conversion plan required by your state's laws.

  • Approval: In addition to the conversion plan, if applicable, it must be approved by the majority of the company's shareholders. If no plan is required, the majority of members must approve the conversion. If the corporate bylaws or articles of incorporation require a certain majority for any vote, the approval of this majority will be required.

  • Filing of required documents: In addition to filing a conversion document or form, which is known by many names, including Articles of Conversion, Certificate of Conversion, and Statement of Conversion, you may need to submit other documents, such as the new LLC Articles of Incorporation and/or an LLC Certificate of Incorporation. The filing fees for the conversion process vary from state to state. When you convert your business to an LLC through your state's corporate entity conversion process, the assets and liabilities of the business will automatically transfer to the LLC.

Tax Consequences

While most states offer this simplified conversion process that lets you convert your corporation to an LLC without following the formal process to dissolve it, you should be aware of the tax consequences that come with changing the structure of your business from a corporation to an LLC as it can be extremely complicated and potentially very expensive, regardless of the process used to convert your corporation. Therefore, it is strongly recommended that you consult with a tax expert before beginning your corporation conversion to an LLC.



Jim McClaflin, EA, NTPI Fellow, CTRC
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