If you're thinking of converting the legal form of your small business from a corporation to a District of Columbia LLC, you should be aware of some basic facts regarding Washington, D.C.'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 the District of Columbia's business-entity conversion statute as it applies to closely-held, for-profit Washington, D.C. corporations converting to multi-member LLCs.
The District of Columbia's Conversion Statute
In Washington, D.C., 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 Department of Consumer and Regulatory Affairs (DCRA). 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. By the same token, there is also no need to dissolve your corporation. Instead, under the D.C. conversion statute, your business is considered to be "the same entity without interruption as" the corporation that existed before the conversion. The conversion procedure is codified primarily in Sections 29-204.01 through 29-204.06 of the District of Columbia Official Code (D.C. Code).
To convert your D.C. corporation to a D.C. LLC you need to:
The plan of conversion contains key information about the conversion; it must include:
The D.C. conversion statute itself does not contain specific rules for approval of the plan of conversion. Instead, you need to rely on the rules for approving a merger, which are contained in D.C.'s corporation merger statute. (A merger is legally distinct from a conversion.) By default under the applicable law, approval requires a simple majority of the shareholders in each share class or voting group entitled to vote. However, the statute also allows for the possibility that a greater vote is required by the articles of incorporation or board of directors. Other requirements may also apply. For more details, check D.C. Code § 29-309.04.
The statement of conversion contains some of the same information as the plan of conversion, as well as a few other items. More specifically, it must include:
A blank statement of conversion form is available for download from the DCRA.
The articles of organization will contain information about your new LLC, including such items as:
For your convenience, the DCRA publishes a blank articles of organization form.
The plan of conversion, statement of conversion, and articles of organization all may appear straightforward. However, keep in mind that you also need to prepare an operating agreement as part of the plan of conversion. Moreover, 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 $220, which is the cost for filing the statement of conversion including the attached articles of organization.
Finally, be aware that Washington, D.C.'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 conversion will not stop pending legal actions against your business. (More specifically, the statute states that "the name of the converted entity"—your new LLC—"may be substituted for the name of the converting entity"—your corporation—"in any pending action or proceeding.") For more information, check D.C. Code § 29-204.06.
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.
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 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, see Nolo's 50-State Guide to Converting a Corporation to an LLC.