If you’re thinking of converting the legal form of your small business from a corporation to a Hawaii 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 Hawaii 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 Hawaii’s business-entity conversion statute as it applies to closely-held, for-profit Hawaii corporations converting to multi-member LLCs.
Hawaii’s Conversion Statute
In Hawaii, you can use a relatively new, simplified procedure that allows you to convert your business from a corporation to an LLC largely by filing a few basic documents with the Department of Commerce and Consumer Affairs (DCCA). This procedure, technically known as “statutory conversion,” 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. By the same token, there is also no need to dissolve your corporation. Instead, under Hawaii’s conversion statute, your business “continue[s] to exist without interruption” in the new form of an LLC. The conversion procedure is codified primarily in Sections 414-271 through 414-274 of the Hawaii Revised Statutes (H.R.S.).
To convert your Hawaii corporation to a Hawaii LLC, you need to:
- have your corporation’s board of directors adopt a plan of conversion
- get the corporation’s shareholders to approve the plan of conversion; and
- file articles of conversion and articles of organization with the DCCA.
The plan of conversion contains key information about the conversion; at a minimum, it should include:
- the name your corporation
- the name of your new LLC
- a statement that your corporation is continuing its existence in the form of a limited liability company
- a statement that the new form of your business will be a limited liability company, and that it will be formed under the laws of Hawaii; and
- the basis for converting corporate shares into LLC membership interests.
The rules governing approval of the plan of conversion will vary depending on when your corporation was formed. By default, a majority of shareholders in each share class entitled to vote must approve the plan for corporation’s incorporated on or after July 1, 1987; for corporations incorporated before that date, the default rule is that three-fourths of all issued shares must approve the plan. However, there are situations in which alternative voting requirements may come into play; for more details, check H.R.S. § 414-313(2).
The articles of conversion contain some of the same basic information as the plan of conversion, as well as a few other items. More specifically, they should include:
- the name of your corporation
- the jurisdiction under which your corporation was formed (Hawaii)
- the legal form of your business before conversion (profit corporation)
- the name of your new LLC
- the jurisdiction under which your new LLC will be formed (Hawaii)
- the legal form of your business after conversion (LLC)
- a statement that the plan of conversion has been approved in accordance with the relevant state laws
- a statement that the plan of conversion is on file at your corporation’s principal place of business, along with the address
- a statement that a copy of the plan of conversion will be provided by your corporation before the conversion, and by your LLC after the conversion, upon written request, and without cost, to any shareholder, partner, member, or owner of your corporation or your new LLC
- a statement regarding the number of shares voting for and against the conversion
- the effective date of the conversion; and
- an authorized signature.
In addition, a copy of the articles of organization must be filed with the articles of conversion. A blank articles of conversion form, including basic instructions, is available for download from the DCCA.
The articles of organization will contain information about your LLC, such as:
- its name
- the mailing address of its principal office
- the name and address of its registered agent in Hawaii
- the names and addresses of each organizer
- its duration
- information regarding whether it will be managed by members or by managers
- names and addresses of each manager or member-manager
- information about individual member liability for debts, obligations, and other liabilities of the LLC; and
- one or more authorized signatures.
The DCCA makes it easier for you to prepare your articles of organization by publishing a blank articles of organization form.
The plan of conversion, articles of conversion, and articles of organization all may appear straightforward. However, converting your particular business may involve unexpected complications. Therefore, it may be advisable to work with a business attorney to draft the required documents and otherwise complete the conversion process.
Your total filing fees for this process likely will be at least $100, which includes filing fees for both the articles of conversion ($50) and the articles of organization ($50). Additional fees, such as for LLC name reservation ($10), may also be necessary.
Finally, be aware that Hawaii’s conversion statute states not only that all of the corporation’s property, as well as all of its liabilities and obligations, are automatically transferred to the new LLC, but also that any legal actions against the corporation may continue against the new LLC without the need to substitute any parties, and all creditors’ rights against the corporation continue unimpaired against the new LLC. For more information, check H.R.S. § 414-274.
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 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 an annual report with the state.
Following the proper LLC formalities is important for maintaining the limited liability status of your business and 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.
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, see Nolo’s 50-State Guide to Converting a Corporation to an LLC.