If you’re thinking of converting the legal form of your small business from a corporation to a South Carolina 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 South Carolina 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 South Carolina’s business-entity conversion statute as it applies to closely-held, for-profit South Carolina corporations converting to multi-member LLCs.
South Carolina’s Conversion Statute
In South Carolina, 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 single document 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. The conversion procedure is codified primarily in Sections 33-11-111 and 33-11-112 of the South Carolina Code of Laws (S.C. Code).
To convert your South Carolina corporation to a South Carolina LLC, you need to:
- have your corporation’s board of directors adopt a plan of conversion (a.k.a. agreement of conversion)
- get the corporation’s shareholders to approve the plan of conversion; and
- file special articles of organization containing information about the conversion with the Secretary of State.
South Carolina’s conversion statute refers, somewhat confusingly, to both a “plan of conversion” and an “agreement of conversion.” It is not clear that there is any distinction between the two terms, and they are used interchangeably here. The only stated requirement regarding the contents of the agreement of conversion is that it include the “terms and conditions” for converting corporation shares into LLC membership interests or other consideration. (You may want to consult with a local attorney for further guidance on this document).
By default, the conversion statute requires approval of the agreement of conversion by a two-thirds majority of the shareholders in each share class or voting group entitled to vote. However, the statute also allows for the possibility that a different vote, including a lesser majority, is required by the articles of incorporation. Other circumstances may also affect the voting rules. For more details, check S.C. Code § 33-11-111.
While many other states require that corporations file both a certificate of conversion and articles of organization to convert to an LLC, in South Carolina you only need to file a single document: a special version of articles of organization which includes conversion information. More specifically, the special articles of organization will include:
- the name of your corporation
- the name of your new LLC
- the name and South Carolina street address of the LLC’s initial registered agent
- the number of shareholder votes for and against the conversion
- either the number or the percentage of votes required to approve the conversion
- the address of the LLC’s initial designated office
- the name and address of each LLC organizer
- optionally, the duration of the LLC
- an indication as to whether the LLC will be member-managed or manager-managed
- if manager-managed, the name and address of each LLC manager
- optionally, information regarding LLC members who will be personally liable for debts
- the effective date for the filing, if other than the filing date
- a statement that your corporation’s articles of incorporation will be cancelled as of the effective date of the filing; and
- one or more authorized signatures.
For your convenience, a blank form for the special articles of organization is available for download from the Secretary of State.
Even if the plan of conversion and special articles of organization strike you as straightforward, you should keep in mind that converting your particular business may involve unexpected complications. As already mentioned above in relation to the plan of conversion, 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 $110, which is the cost for filing the special articles of organization.
Finally, be aware that South Carolina’s conversion statute states not only that all of your corporation’s property, as well as all of its debts, liabilities, and other obligations, are automatically transferred to the new LLC, but also that any legal actions against your business may continue “as if the conversion has not occurred.” For more information, check S.C. Code § 33-11-112.
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.
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, check Nolo’s 50-State Guide to Converting a Corporation to an LLC.