If you’re thinking of converting the legal form of your small business from a corporation to a Colorado 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
- corporations formed under Colorado 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 Colorado’s business-entity conversion statute as it applies to closely-held, for-profit Colorado corporations converting to multi-member LLCs.
Colorado’s Conversion Statute
In Colorado, 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 forms with the Secretary of State. This procedure, technically known as “statutory conversion,” will automatically convert your corporation to an LLC and automatically transfer your corporation’s assets and liabilities to that new LLC. Unlike other methods of conversion, only one business entity is involved, and 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; on the contrary, under Colorado’s conversion statute, the one business entity involved in the conversion, which is originally a corporation, is considered by default to continue its existence in the form of an LLC. The conversion procedure is codified primarily in Sections 7-90-201 through 7-90-202 of the Colorado Revised Statutes.
To convert your Colorado corporation to a Colorado LLC, you need to:
- prepare a plan of conversion that is adopted by the board of directors
- get the corporation’s stockholders to approve the plan of conversion; and
- file a statement of conversion and articles of organization with the Secretary of State.
The plan of conversion contains key information about the conversion; at a minimum, it must provide:
- the fact that your business is currently formed as a corporation
- the name of your corporation
- the state where your corporation was formed (Colorado)
- the fact that after conversion your business will be an LLC
- the name of your LLC
- the state law under which your LLC will be formed (Colorado); and
- “the terms and conditions of the conversion,” including the basis on which shareholders’ stock will be converted into LLC membership interests.
By default, the Colorado conversion statute requires approval of the plan of conversion by a simple majority of all votes entitled to be cast. However, the statute also lays out various possible alternative voting requirements for approving a plan; for more details, check CRS § 7-111-103. Depending on your level of expertise, it may be advisable to seek the assistance of an attorney in preparing this document.
The statement of conversion is a relatively simple document that provides basic information primarily about your corporation, such as its name, the state where it was formed, and its address, as well as a statement that the corporation is being converted into an LLC pursuant to the Colorado conversion statute, and the name and address of the person filing the statement.
The LLC’s articles of organization, which must be filed with the statement of conversion, will contain certain basic information about the new form of your business, including the name and address of the LLC and of the person filing the articles, as well as the numbers of managers and members.
You can download a single PDF file containing blank templates of both the statement of conversion and articles of organization, as well as helpful instructions for the statement of conversion, from the Secretary of State’s website. Note that while the statement of conversion and articles of organization may appear straightforward, some of the issues involved in converting your particular business may involve unexpected complications, particularly with regard to the articles of organization; therefore, it may be advisable to consult with a business attorney before completing these documents.
The total filing fees for this process should be $100, which includes $50 to file the statement of conversion and $50 to file the articles of organization.
Colorado’s conversion statute states broadly that all of your corporation’s obligations, which generally would include things like debts and other liabilities, as well as lawsuits, carry over to your business in its new form as an LLC. For more information, check CRS § 7-90-202.
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’s 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 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 entity change.
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.