If you’re thinking of converting the legal form of your small business from a Maryland corporation to a Maryland LLC, you should be aware of some basic facts regarding the state’s business-entity conversion process. 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.
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, Maryland is one of only about ten states that do not allow statutory conversions of corporations to LLCs; instead, Maryland only allows statutory mergers. Unlike statutory conversions, statutory mergers do require you to form a separate LLC before you can convert—or, more accurately, merge—your business.
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 Maryland 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 Maryland’s merger statutes as they apply to closely-held, for-profit Maryland corporations merging into multi-member LLCs.
Maryland’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 Maryland’s merger statutes. Like most states, Maryland has one merger statute under its General Corporation Law and another merger statute under its Limited Liability Company Act; portions of each of these statutes apply to a corporation-into-LLC merger. For details, check Sections 3-101 through 3-114 and Sections 4A-701 through 4A-709 of the Maryland Corporations and Associations Code Annotated (MCACA).
To convert your Maryland corporation to a Maryland LLC via a statutory merger, you need to:
- create a new LLC
- have your corporation’s board of directors adopt a resolution to merge
- obtain stockholder approval of the proposed merger
- obtain LLC member approval of the merger; and
- file articles of merger with the Department of Assessments and Taxation.
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 Department of Assessments and Taxation. Through these LLC organizational documents, the stockholders of your preexisting corporation will also become the members of your new LLC. For more detailed information on forming an LLC in Maryland, check How to Form an LLC in Maryland. 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).
Steps 2 and 3: Board Adoption of Resolution and Stockholder Approval of Merger
On the corporation side of this transaction, the board of directors must adopt a resolution containing the terms and conditions of the merger and stating that the merger is advisable; the stockholders must then approve the merger. (For a small business, the directors may well be the same people as the stockholders.) Approval of the merger requires a two-thirds majority of all votes entitled to be cast on the matter. Unlike some other states, the statute does not allow for the possibility that the articles of incorporation or board of directors may require a different majority vote. For more details, check MCACA § 3-105.
Step 4: LLC Approval of Plan
On the LLC side of this transaction, you should follow the provisions in your operating agreement, or other relevant agreement, for approving mergers. If no such provisions exist, then approval requires the consent of at least two-thirds of the LLC interests in profits. Generally speaking, where the LLC is formed for the primary purpose of the merger, and the stockholders 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 MCACA § 4A-702(f).
Step 5: File Articles of Merger
Under Maryland law, the articles of merger are required to contain the following pieces of important information about the merger:
- the “terms and conditions” of the merger
- a statement that your corporation and your new LLC agree to merge
- the name and place of incorporation of your corporation (place of incorporation = Maryland)
- the name prior to the merger and place of organization of your new LLC (place of organization = Maryland)
- the name of your LLC after the merger
- a statement of the Maryland county where your corporation has its principal office
- a statement of the Maryland county where your new LLC has its principal office
- a statement of each Maryland county where your corporation owns an interest in land
- a statement of each Maryland county where your new LLC owns an interest in land
- a statement that the terms and conditions contained in the articles of merger “were advised, authorized, and approved” by your corporation as required by its articles of incorporation and by Maryland law, including “a statement of the manner of approval”
- a statement that the terms and conditions contained in the articles of merger “were advised, authorized, and approved” by your new LLC as required by its articles of organization and by Maryland law, including “a statement of the manner of approval”
- any amendment to the your new LLC’s articles of organization to be effected by the merger
- for your corporation, the total number of shares, including the number in each class, the par value in each class, and the aggregate par value of all shares
- for your new LLC, the percentages of membership interests of each class of LLC membership interest and the class of members and respective percentage of membership interests in each class of membership interest
- the manner and basis for converting corporation stock into LLC membership interests.
Note that some of these required items may not apply to your merger; for example, your business might not own any land at the time of the merger. The Department of Assessments and Taxation does not provide a blank form or template for the articles of merger; you will have to draft your own.
Other Important Advice
Some people may consider the formation of the new LLC, the merger approval process, and the articles of merger all to be straightforward. However, as mentioned above, mergers are complex transactions and often involve unexpected complications. Therefore, you should very strongly consider working with a business attorney to draft the required documents and otherwise complete the merger process.
Your minimum filing fees for this process will be at least $200, which includes $100 for filing the articles of organization for the new LLC, and $100 for filing the articles of merger.
The merger statute under Maryland’s LLC Act states not only that all of your corporation’s property, as well as all of its debts and liabilities, are transferred to the new LLC, but also that the rights of creditors against your business continue unimpaired, and any legal actions against your business “May be prosecuted to judgment 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 MCACA § 4A-709.
Apart from the items mentioned in How to Form an LLC in Maryland, 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 stockholders 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.