If you’re thinking of converting the legal form of your small business from a Montana corporation to a Montana 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, Montana is one of only about ten states that do not allow statutory conversions of corporations to LLCs. Instead, Montana only allows statutory mergers. Unlike statutory conversions, statutory mergers dorequire 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:
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 Montana’s merger statutes as they apply to closely-held, for-profit Montana corporations merging into multi-member LLCs.
Montana’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 Montana’s merger statutes. Like most states, Montana has one merger statute under its Business Corporation Act and another merger statute under its Limited Liability Company Act; portions of each of these statutes apply to a corporation-into-LLC merger. For some of the most important parts of each of the two statutes, check Section 35-1-815 and Sections 35-8-1201 through 35-8-1203 of the Montana Code Annotated (MCA).
To convert your Montana corporation to a Montana LLC via a statutory merger, you need to:
Step 1: Create an LLC
Creating an LLC is a multi-step process. However, for immediate purposes, the key elements are preparing a certificate of formation and an operating agreement; the certificate of formation will be filed with the Secretary of State. Through these LLC organizational documents, the shareholders of your preexisting corporation will also become the members of your new LLC. For more detailed information on forming an LLC in Montana, check How to Form an LLC in Montana. 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).
Step 2: Prepare a Plan of Merger
As its name suggests, the plan of merger will contain details about the merger; it must include:
Steps 3 and 4: Board Adoption and Shareholder Approval of Plan
On the corporation side of this transaction, the plan of merger must be adopted by the board of directors, and then approved by the shareholders. (For a small business, the directors may well be the same people as the shareholders.) By default, shareholder approval of the plan requires a two-thirds majority of the votes in each voting group entitled to vote separately on the plan. However, the statute allows for the possibility that the articles of incorporation or board of directors require a different majority vote by shareholders. For more details, check MCA § 35-1-815.
Step 5: LLC Approval of Plan
On the LLC side of this transaction, approval requires the consent of the number or percentage of LLC members specified in your LLC’s operating agreement. If there are no provisions in the operating agreement regarding approval of mergers, approval requires the consent of all LLC members. Generally speaking, where the LLC is formed for the primary purpose of the merger, and the shareholders 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 MCA § 35-8-1201(3).
Step 6: File Articles of Merger
The articles of merger must include:
Note that many of the listed items may well already be contained in your plan of merger. The Secretary of State 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 plan of merger, the agreement 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 strongly consider working with a business attorney to draft the required documents and otherwise complete the merger process.
Your total filing fees for this process likely will be at least $90, which includes $70 for filing the articles of organization for the new LLC and $20 for filing the articles of merger.
Be aware that the merger statute under Montana’s LLC Act states not only that all of your corporation’s property, as well as all of its debts, liabilities, and other obligations, are transferred to the new LLC, but also that any legal actions against your business “may be continued as if the merger had not occurred”—or your new LLC may be substituted for your old corporation as a party in such actions. For more information, check MCA § 35-8-1203.
Apart from the items mentioned in How to Form an LLC in Montana, 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.
A key point to keep in mind is that 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 shareholders 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.