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.
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:
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 business-entity conversion statute as it applies to closely-held, for-profit Maryland corporations converting to multi-member LLCs.
In Maryland, you can use a relatively new, simplified procedure that allows you to convert your business from a corporation to an LLC. Under the new procedure, your main task is to file a few basic documents with the MarylandState Department of Assessments and Taxation (SDAT). 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. The conversion procedure is codified primarily in Sections 3-901 through 3-907 of the Maryland Corporations and Associations Code Annotated (MCACA).
To convert your Maryland corporation to a Maryland LLC, you need to:
Unlike some other states with conversion statutes, Maryland does not require a plan of conversion in addition to the resolution to convert and the articles of conversion.
By default, Maryland’s conversion statute requires approval of the proposed conversion by a two-thirds majority of the corporation stockholders. However, the statute allows for different rules for conversion, including different voting requirements, if they are stated in your corporation’s charter.
The articles of conversion must contain basic information about the conversion, including:
Unlike other states, SDAT does not currently have a template or form for the articles of conversion that you can download.
The articles of conversion, as well as other paperwork such as the resolution to convert, 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 minimum filing fee for this process likely will be $100, which is the cost for filing the articles of conversion with SDAT.
All of your corporation’s assets and property, as well as all of its debts and obligations, are automatically transferred to the new LLC. In addition, be aware that any claim, action, or proceeding against your business—such as lawsuits—may continue “as if the conversion had not taken place.”
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:
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).
Maryland’s conversion statute states that conversion does not invalidate, terminate, suspend, or nullify any licenses, permits, or registrations granted to your corporation. Nonetheless, one other key step is to make sure that no business contracts or agreements, such as bank documents, leases, and insurance, will be affected 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 conversion 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 stockholders 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 Converting a Corporation or S Corporation to an LLC and 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.