If you’re thinking of converting the legal form of your small business from a corporation to an Alabama LLC, you should be aware of some basic facts regarding the state’s business-entity conversion process. In general, the tax consequences associated with converting from a corporation to an LLC will be complicated. Therefore, for any kind of corporation-to-LLC conversion, you should consult with an experienced tax adviser.
Variable Elements of Conversions
First, let’s be clear that there is not just one kind of corporation, one tax status for an LLC, or one kind of conversion. On the contrary, there are:
- C corporations and S corporations
- for-profit corporations and non-profit corporations
- corporations formed under Alabama law and corporations formed under other states’ laws
- multi-member LLCs and single-member LLCs
- LLCs taxed as partnerships, LLCs taxed as corporations, and LLCs taxed as “disregarded entities;” and
- multiple methods for converting your business—including statutory conversions, statutory mergers, and nonstatutory conversions
We won’t be looking at every possible combination of these variables. Instead, we’ll try to keep matters as simple as possible, focusing mainly on the general rules of Alabama’s business-entity conversion laws as they apply to closely-held, for-profit Alabama corporations converting to multi-member LLCs.
Alabama’s Conversion Statute
Alabama has a somewhat simplified procedure for converting your business from a corporation to an LLC. Technically known as “statutory conversion,” the procedure automatically transfers your corporation’s assets and liabilities to the new LLC. Unlike other methods of conversion, only one business entity is involved: you do not need to separately form an LLC before the conversion can occur. (As the conversion statute puts it, a converted entity [the new LLC] “is for all purposes the same entity that existed before the conversion.”)
Because the majority of states allow for statutory conversion, it is worth noting that Alabama’s conversion statute is different from the conversion statutes of most other states in several respects. First, unlike many other states’ conversion statutes, Alabama’s statute includes language regarding “termination” of a business entity prior to conversion; however, personnel at the Secretary of State caution that you should not dissolve your corporation. Second, unlike other states, many documents needed to create new business entities are not filed with the Secretary of State or similar state office, but instead with the Office of the Judge of Probate in the appropriate county. However, you should file your conversion documents directly with the Secretary of State, who will then transmit copies to the appropriate Judge of Probate. The conversion procedure is codified primarily in Section 10A-1-8.01 of the Code of Alabama (Code of Ala.).
To convert your Alabama corporation to an Alabama LLC, you need to:
- get the corporation’s stockholders to approve the conversion
- obtain a name reservation certificate for the new corporation from the Secretary of State; and
- file a certificate of formation and a copy of the name reservation certificate for the new LLC with the Secretary of State.
By default, the Alabama conversion statute requires approval of the conversion by all shares entitled to vote. However, the statute also allows for possible alternative voting requirements—although in no case may a conversion be approved by less than a simple majority of votes in each voting group entitled to vote separately. For more details, check Code of Ala. § 10A-1-8.01(a)(1)b.
You can obtain information on the name reservation process in this Nolo article on forming an LLC in Alabama. Alternatively, you can visit the Alabama Secretary of State’s webpage on organizing an LLC.
A certificate of formation generally is necessary to form an LLC in Alabama regardless of whether the LLC is formed as part of a statutory conversion. A standard certificate of formation will contain basic information about your new LLC, such as:
- the name of your new LLC
- street address of the principal office, and, if different, the mailing address of the principal office
- street address of the LLC’s registered agent, and, if different, the mailing address of the registered agent
- a statement of the LLC’s purpose
- the names and addresses of the LLC’s organizers
- the number of LLC managers, if any, along with their names and addresses
- the effective date for the LLC’s formation; and
- an authorized signature.
In addition, a certificate of formation filed as part of a statutory conversion also must include:
- a statement that the new LLC was converted from another entity
- the name of the preexisting corporation
- the public office where the certificate of formation for the preexisting corporation is filed; and
- a statement that the conversion was approved in accordance with Code of Ala. Section 10A-1-8.01.
And, finally, you must attach a copy of the name reservation certificate for your LLC to the certificate of formation.
At this time, there is no certificate of formation form available for download that includes blanks for entering all of the necessary information for a statutory conversion. However, the Secretary of State currently does have a draft version of such a conversion form in Microsoft Word format. They should be able to email you a copy of this form upon request.
While the special certificate of formation, the name reservation certificate, and the underlying approval process, may appear straightforward, converting your particular business may involve unexpected complications. Moreover, as already mentioned, there are some unusual elements under Alabama’s law. Therefore, you should strongly consider contacting a business attorney for assistance.
There are several potential filing fees involved in this process. Filing the certificate of formation involves a $25 fee payable to the Secretary of State plus an additional fee for the Probate Court where you’ll file the form. (The Secretary of State’s draft conversion form states that you should contact the Probate Court regarding their fees). Name reservation costs $10.
Alabama’s conversion statute states not only that title to all of the corporation’s property, as well as all of the corporation’s debts and liabilities, are automatically transferred to the new LLC, but also that any legal actions against the corporation may continue “as if the conversion had not occurred,” or the new LLC may be substituted for the corporation as a party. For more information, check Code of Ala. § 10A-1-8.01(d).
Apart from the foregoing steps, you will also need to take care of all the tasks normally associated with creating and running a new LLC, such as:
- drafting your LLC’s operating agreement
- notifying customers, clients, suppliers, and others with whom your business has relationships of its new status as an LLC
- holding required LLC meetings (such as member or manager meetings)
- keeping proper minutes of LLC meetings
- keeping LLC finances separate from personal finances
- using the official LLC name on your business documents; and
- filing the required annual report with the state.
Following the proper LLC formalities is important for maintaining the limited liability status of your business and for ensuring certain potential tax benefits. For a more complete discussion of the steps involved in forming and running an LLC, consult Your Limited Liability Company: An Operating Manual, by Anthony Mancuso (Nolo).
One other key step in the conversion process is to make sure that no business contracts or agreements, such as bank documents, leases, licenses, and insurance, will be nullified by your business’s conversion.
A key point to keep in mind is that converting a C corporation to an LLC taxed as a partnership often results in a large tax bill. This is largely because the IRS considers this kind of conversion to be a liquidation of the corporation for which the corporation will owe tax, on top of which the corporation’s stockholders will also be taxed personally on the corporate assets assumed to be distributed to them; in other words, there is double taxation.
Converting a corporation to an LLC that will continue to be taxed as a corporation generally does not have the same degree of adverse tax consequences as when converting to an LLC taxed as a partnership, and may even be largely tax-free. However, as this type of conversion will not change the basic elements of how your business will be taxed going forward, you should investigate closely how it would benefit the business, other than by providing a more flexible management structure. Also, in order for your LLC to continue to be taxed as a corporation, you must file a special election form with the IRS.
Converting from an S corporation to an LLC is fundamentally different from converting from a C corporation, because an S corporation has only one level of taxation. As a rule, an S corporation itself does not pay tax, only its shareholders do. Therefore, the tax consequences for this type of conversion are often more limited than conversions from a C corporation.
In general, the tax consequences associated with converting from a corporation to an LLC will be complicated. Therefore, for any kind of corporation-to-LLC conversion, you should consult with an experienced tax adviser.
For further guidance on converting from a corporation to an LLC, check Corporations and S Corporations vs. LLCs. Also, while they are not a substitute for expert tax advice, you should also consider looking at Tax Savvy for Small Business, by Frederick Daily (Nolo), and Legal Guide for Starting & Running a Small Business, by Fred Steingold (Nolo). For information on conversion rules in other states, check Nolo’s 50-State Guide to Converting a Corporation to an LLC.