If you're thinking of converting the legal form of your small business from a New York corporation to a New York LLC, you should be aware of some basic facts regarding the state's business-entity conversion process. Because the tax consequences can be significant, you should consult with a tax adviser before undertaking any conversion.
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, New York is one of only about ten states that do not allow statutory conversions of corporations to LLCs. Instead, New York 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:
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 New York's merger statutes as they apply to closely-held, for-profit New York corporations merging into multi-member LLCs.
New York'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 New York's merger statutes. As in most states, New York has one merger statute under its corporations laws and another merger statute under its LLC laws; portions of each of these statutes apply to a corporation-into-LLC merger. For the most important parts of each of the two statutes, check Sections 901 through 906 of Article 9 of the New York's Business Corporations laws (NY CLS Bus. Corp.) and Sections 1001 through 1004 of Article 10 New York's Limited Liability Company laws (NY CLS LLC).
To convert your New York corporation to a New York 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 articles of organization and an operating agreement; the articles of organization will be filed with the Department 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 New York, check How to Form an LLC in New York. Note: Initially, the name of your corporation cannot also be used as the name of your new LLC. However, you can specify in the agreement 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 an Agreement of Merger
As its name suggests, the agreement of merger will contain details about the merger. It must include:
Steps 3 and 4: Corporation Board and Shareholder Approval of Agreement
On the corporation side of this transaction, the agreement of merger must be adopted by a majority vote of the board of directors, and then approved by the shareholders. (For a small business, the directors may be the same people as the shareholders.) The rules for shareholder approval of the agreement of merger will vary depending on, among other things, when your corporation was formed and whether there are any merger approval provisions in your certificate of incorporation. In many cases, approval will require at least two-thirds of the votes of all outstanding shares entitled to vote on the plan, unless your certificate of incorporation requires a lesser majority vote. For more details, check NY CLS Bus. Corp. § 903. Because the variety of potential voting rules contained in the statute can be confusing, you should consider consulting with a business attorney for guidance.
Step 5: LLC Approval of Agreement
On the LLC side of this transaction, the plan must be approved by whatever percentage of members is required by the LLC's operating agreement, so long as it is at least a simple majority. If the operating agreement has no provision for approving mergers, then approval requires a simple majority vote of member interests. 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 NY CLS LLC § 1002.
Step 6: File a Certificate of Merger
The certificate of merger will contain some of the same information as the plan of merger, as well as a few other items. More specifically, it will include:
The certificate of merger must also be headed with the phrase "Certificate of Merger of [name of your corporation] and [name of your new LLC prior to merger] into [name of your LLC after merger] under Section 1003 of the Limited Liability Company Law." A blank certificate of merger form specifically for mergers of New York corporations into LLCs is available for download from the Department of State.
Other Important Advice
Some people may consider the formation of the new LLC, the agreement of merger, the agreement approval process, and the certificate of merger all to be straightforward. However, as mentioned above, mergers are generally 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 probably will be at least $260, which includes $200 for filing articles of organization for the new LLC and $60 for filing the certificate of merger.
New York's LLC merger statute states not only that all of your corporation's property, as well as all of its debts, liabilities, and obligations, are transferred to the new LLC, but also that any legal actions against your business "may be enforced, prosecuted, settled or compromised 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 NY CLS LLC § 1004.
Apart from the items mentioned in How to Form an LLC in New York, 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.
Tax Consequences
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.