If you’re thinking of converting the legal form of your small business from a Connecticut corporation to a Connecticut LLC, you should be aware of some basic facts regarding the state’s business-entity conversion process. Because the tax consequences can be significant, you should consult with a tax adviser before undertaking any conversion.
Statutory Conversions vs. Statutory Mergers
As an initial point, be aware that there is a distinction between a “conversion” and a “merger,” and more specifically between a “statutory conversion” and a “statutory merger.” A statutory conversion is a cheaper, quicker way to convert a corporation to an LLC—largely because you do not have to form a separate LLC before the conversion can occur. However, Connecticut is one of about ten states that do not allow statutory conversions of corporations to LLCs. Instead, Connecticut only allows statutory mergers. Unlike statutory conversions, statutory mergers dorequire you to form a separate LLC before you can convert—or, more accurately, merge—your business.
Note: In 2011, the Connecticut legislature amended its business entity laws. Consequently, effective January 1, 2014, it will be possible to convert corporations to LLCs via statutory conversions; in the meantime, however, only statutory mergers are available.
Notwithstanding the distinction between statutory conversions and statutory mergers, “conversion” is a more general term that can include mergers. In this article, we’ll use “conversion” and “merger” somewhat interchangeably, sometimes speaking broadly about “conversions” and “converting” your business, even though, more narrowly and technically, we’ll be talking about a merger.
Variable Elements of Conversions
Before looking at the specific steps for converting your business, let’s be clear that there is not just one kind of corporation or one tax status for an LLC. On the contrary, there are:
- C corporations and S corporations
- for-profit corporations and non-profit corporations
- corporations formed under Connecticut law and corporations formed under other states’ laws
- multi-member LLCs and single-member LLCs; and
- LLCs taxed as partnerships, LLCs taxed as corporations, and LLCs taxed as “disregarded entities.”
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 Connecticut’s merger statutes as they apply to closely-held, for-profit Connecticut corporations merging into multi-member LLCs.
Connecticut’s Merger Statutes
Bearing in mind that mergers can be among the most complicated of business transactions, this section provides a very brief summary of the process of conversion-via-merger under Connecticut’s merger statutes. As in most states, Connecticut has one merger statute under its corporations laws and another merger statute under its LLC laws; portions of each of these statutes apply to a corporation-into-LLC merger. For the most important parts of each of the two statutes, check Sections 33-815 through 33-821a and 34-193 through 34-197 of of the Connecticut General Statutes (Conn. Gen. Stat.).
To convert your Connecticut corporation to a Connecticut LLC via a statutory merger, you need to:
- create a new LLC
- prepare a plan of merger
- have your corporation’s board of directors adopt the plan of merger
- obtain shareholder approval of the plan of merger
- obtain LLC member approval of the plan of merger; and
- file articles of merger with the Secretary of the State.
Step 1: Create an LLC
Creating an LLC is a multi-step process. However, for immediate purposes, the key elements are preparing articles of organization and an operating agreement; the articles of organization will be filed with the Secretary of the State. Through these LLC organizational documents, the shareholders of your preexisting corporation will also become the members of your new LLC. For more detailed information on forming an LLC in Connecticut, check How to Form an LLC in Connecticut. Note: Initially, the name of your corporation cannot also be used as the name of your new LLC. However, you can specify in the plan of merger that the name of the LLC will be changed to the name of your corporation when the corporation merges into the LLC (at which point the corporation ceases to exist).
Step 2: Prepare a Plan of Merger
As its name suggests, the plan of merger will contain details about the merger; it must include:
- the name of your corporation and the name of your LLC prior to the merger
- the name of your LLC after the merger
- the “terms and conditions” of the merger
- the basis for converting corporation shares into LLC membership interests
- any amendments to the new LLC’s articles of organization (such as a change in name); and
- any other provisions that may be required by your corporation’s certificate of incorporation or your new LLC’s articles of organization.
Steps 3 and 4: Corporation Board and Shareholder Approval of Plan
On the corporation side of this transaction, the plan of merger must be adopted by a majority vote of the board of directors, and then approved by the shareholders. (Of course, for a small business, the directors may well be the same people as the shareholders.) By default, approval of the plan of merger requires a simple majority of all votes in each voting group entitled to vote on the plan. However, the statute allows for the possibility that the certificate of incorporation or the board of directors will require a greater majority vote. For more details, check Conn. Gen. Stat. 33-817.
Step 5: LLC Approval of Plan
On the LLC side of this transaction, the plan must be approved either by at least two-thirds of the LLC membership interests, unless the LLC’s articles of organization or operating agreement provide otherwise. Generally speaking, where the LLC is formed for the primary purpose of the merger, and the shareholders of the corporation are also the members of the LLC, it should be the case that all LLC members will approve the merger. For more details, check Conn. Gen. Stat. 34-194.
Step 6: File Articles of Merger
The articles of merger—to which your plan of merger will be attached—will repeat some of the same information as the plan of merger, as well as a few other items. More specifically, the articles of merger will include:
- the name of your corporation and its jurisdiction of formation (= Connecticut)
- the name of your new LLC prior to the merger and its jurisdiction of formation (= Connecticut)
- the name of your LLC after the merger
- the effective date of the merger, if later than the filing date
- a statement that the plan of merger was duly authorized and approved by your corporation and your new LLC in accordance with the provisions of Conn. Gen. Stat. Sections 34-194 and 33-817
- any amendments to your new LLC’s articles of organization (such as a change in name)
- a statement that the plan of merger is on file at your new LLC’s place of business, including the address; and
- a statement that your new LLC will provide a copy of the plan of merger, on request and at no cost, to any of the shareholders of your corporation or members of your new LLC.
At this time, no template or blank form for the articles of merger is available from the Secretary of the State; you will have to draft your own.
Other Important Advice
Some people may consider the formation of the new LLC, the plan of merger, the plan approval process, and the articles of merger all to be straightforward. However, as mentioned above, mergers are generally complex transactions, and often involve unexpected complications. Therefore, you should strongly consider working with a business attorney to draft the required documents and otherwise complete the merger process.
Your minimum filing fee for this process probably will be $60, which is the cost for filing the articles of merger.
Connecticut’s LLC merger statute states not only that all of your corporation’s property, as well as all of its debts, liabilities, and other obligations, are transferred to the new LLC, but also that the merger does not impair the rights of creditors relative to business property, and any legal actions against your business may continue “as if [the] merger had not taken place”—or your new LLC may be substituted for your old corporation as a party in such actions. For more information, check Conn. Gen. Stat. 34-197.
Apart from the items mentioned in How to Form an LLC in Connecticut, one other important step when undertaking this type of merger is to make sure that no business contracts or agreements, such as bank documents, leases, licenses, and insurance, will be nullified by your corporation’s conversion to an LLC.
Merging a C corporation into an LLC taxed as a partnership often results in a large tax bill. This is largely because the IRS considers this kind of merger 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.
Merging a corporation into an LLC that will continue to be taxed as a corporation generally does not have the same degree of adverse tax consequences as when merging into an LLC taxed as a partnership, and may even be largely tax-free. However, as this type of merger 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.
Merging an S corporation into an LLC is fundamentally different from a merger involving 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 merger are often more limited than mergers involving a C corporation.
In general, the tax consequences associated with merging your corporation into an LLC will be complicated.Therefore, for any kind of corporation-into-LLC merger, you should consult with an experienced tax adviser.
Additional Reading and Guidance
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 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). And, finally, for information on conversion rules in other states, check Nolo’s 50-State Guide to Converting a Corporation to an LLC.