If you're thinking of converting the legal form of your small business from a corporation to a Virginia 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:
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 Virginia's business-entity conversion statute as it applies to closely-held, for-profit Virginia corporations converting to multi-member LLCs.
Virginia's Conversion Statute
In Virginia, 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 documents with the State Corporation Commission. 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 13.1-722.8 through 13.1-722.14 of the Code of Virginia (Va. Code).
To convert your Virginia corporation to a Virginia LLC, you need to:
The statutory requirements for the plan of conversion are stated briefly and broadly: the plan needs to contain the "terms and conditions" of the conversion, including the basis for converting corporation shares into LLC membership interests. Also, the articles of organization for your new LLC must be attached to the plan of conversion.
By default, Virginia's conversion statute requires approval of the plan of conversion by a two-thirds majority of the shareholders in each voting group entitled to vote. However, the statute also allows for other possibilities, including that the board of directors requires a greater majority vote, or that the articles of incorporation provide for a greater or lesser majority vote. For more details, check Va. Code § 13.1-722.11(A).
The articles of entity conversion, which must include the plan of conversion and the articles of organization, contain basic information about the conversion, including:
The State Corporation Commission publishes an excellent template and instructions for the articles of entity conversion. You can use this template as a guide to prepare your own articles of entity conversion.
The articles of organization for your new LLC will include:
For your convenience, the State Corporation Commission publishes a blank articles of organization form.
The plan of conversion, articles of entity conversion, and articles of organization all 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 entity conversion including the articles of organization and a copy of the plan of conversion.
Finally, be aware that Virginia's conversion statute states not only that all of your corporation's property, as well as all of its liabilities, are automatically transferred to the new LLC, but also that any legal proceedings against your business may continue "as if the conversion did not occur." For more information, check Va. Code § 13.1-722.13.
Additional Steps
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).
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.
Tax Consequences
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.
Additional Information
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, see Nolo's 50-State Guide to Converting a Corporation to an LLC.