If you’re thinking of converting the legal form of your small business from a corporation to a Kentucky LLC, you should be aware of some basic facts regarding the state’s business-entity conversion process.
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 Kentucky 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 Kentucky’s business-entity conversion statute as it applies to closely-held, for-profit Kentucky corporations converting to multi-member LLCs.
Kentucky’s Conversion Statute
In Kentucky, 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 Secretary of State. 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. (As the law states, your business is “for all purposes the same entity that existed before the conversion.”) The conversion procedure is codified primarily in Sections 275.376 and 275.377 of the Kentucky Revised Statutes (K.R.S.).
To convert your Kentucky corporation to a Kentucky 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 a special version of articles of organization with the Secretary of State.
The plan of conversion contains key information about the conversion, including such things as:
- the name of your corporation
- the manner and basis for converting corporate shares into LLC membership interests
- the new LLC’s articles of organization and operating agreement; and
- any other terms and conditions of the conversion.
The inclusion of the articles of organization and operating agreement appears to be optional; more specifically, the statute states that “the plan of conversion shall set forth . . . the articles of organization and operating agreement, if any . . .” (emphasis added). However, in practice, you will probably want to have those documents prepared and included with the plan of conversion to ensure that all relevant parties are aware of the details of the LLC that will exist after the conversion is complete.
By default, Kansas’s conversion statute requires that the plan of conversion be approved by a majority of all shareholder votes in each voting group entitled to vote. However, the statute also specifically allows for the possibility that this default rule will be superceded and a greater vote required, due to, for example, a provision in your articles of incorporation, or a condition imposed by the board of directors. For more details, check K.R.S. § 275.376(8).
Unlike many other states that have conversion statutes, Kentucky does not use a separate certificate of conversion in conjunction with articles of organization. Instead, you need to prepare standard articles of organization, and then add a few additional items of information. The standard articles of organization include:
- the name of your new LLC
- the street address of the registered office in Kentucky
- the name of the registered agent
- the mailing address of the principal office
- whether the LLC is to be managed by a manger or by the LLC members
- the effective date for the filing, if other than the filing date; and
- one or more authorized signatures.
In addition, when filing articles of organization as part of a conversion, you also need to include the following information:
- a statement that your corporation was converted to an LLC
- the former name of your business (i.e., the name of your corporation)
- information about the number of votes to be cast by each voting group to approve the conversion; and
- either the number of votes approving the plan of conversion, or a statement that the number of votes cast by each group was sufficient for approval by that group.
For your convenience, a blank articles of organization form is available for download from the Secretary of State. The form does not include any spaces for the foregoing information specifically regarding conversion from a corporation.
The plan of conversion and articles of organization both may appear straightforward; however, keep in mind that you will also likely need to prepare an operating agreement as part of the plan of conversion. Moreover, 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 minimum filing fee for this process likely will be $40, which is the cost for filing articles of organization.
As a final point, be aware that Kentucky’s conversion statute states not only that all of your corporation’s property, as well as all of its liabilities, are automatically transferred to the new LLC, but also that but also that any legal actions against your business may continue “as if the conversion had not occurred,” and the name of your LLC may be substituted for that of your corporation in any such action. For more information, check K.R.S. § 275.377(2).
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:
- 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 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 advisor.
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.