The process for converting your small business from a corporation to a limited liability company (LLC) will vary depending on multiple factors. While we can't cover every possible variation, here's a quick look at some of the more basic issues for this type of conversion.
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You might decide to switch from a corporation to an LLC because an LLC provides advantages that a corporation doesn't. If you have a small business, you might particularly benefit from an LLC's customizable structure.
Let's look at a few of the ways an LLC might be preferable to a corporation:
However, if your corporation is already taxed as an S corp and you don't need to differentiate between ownership shares and profit shares, then you might not see much benefit from converting your corporation to an LLC.
For more, read about the differences between LLCs and corporations.
First, there isn't just one tax status for an LLC, one kind of corporation, or one kind of conversion. On the contrary, there are:
With these variables in mind, it's important to understand the differences in business and tax structures and in conversion methods. Here we'll try to simplify matters and look mainly at closely-held C corporations converting to multi-member LLCs (the most common scenario).
There are three types of conversion methods that states recognize. You should check your state's business laws to see which type of conversions your state allows.
A statutory conversion is a relatively new, streamlined procedure that's available in many states. This method allows you to convert your corporation to an LLC by filing a few forms with the secretary of state's office. Each state that allows statutory conversions has its own specific forms and rules.
However, generally speaking, steps for a statutory conversion include:
While there are important technical distinctions between a statutory conversion and other types of conversions, the practical effects are the same:
A key point about statutory conversions is that all these effects occur automatically by operation of law rather than through separate, formal agreements. Though you should still address how corporate stock will be exchanged for membership interests in either your plan of conversion or in a separate agreement.
Statutory conversion is usually the quickest and most inexpensive way to convert from a corporation to an LLC. In those states where it's available, this type of conversion will generally be your best option.
A statutory merger is more complicated than a statutory conversion. However, if your state doesn't allow for statutory conversions, you'll likely use this method. While specific details will vary from state to state, the basic steps of a statutory merger usually include:
Like with a statutory conversion, a statutory merger automatically transfers your corporation's assets and liabilities to the new LLC by operation of law. However, unlike statutory conversions, you'll likely have to file a form that formally dissolves your corporation.
Apart from the conversions and mergers that are specifically laid out in state law, you can find a workaround solution to convert your corporation into an LLC with a nonstatutory conversion.
A nonstatutory conversion is generally the most complicated and expensive way to convert from an LLC to a corporation. You'll have to not only legally form your LLC and formally exchange corporation shares for LLC membership interests (as with a statutory merger), but you'll also have to undertake the process of transferring your corporation's assets and liabilities to your newly formed LLC.
As part of this process, you'll need to formally liquidate and then dissolve the corporation, including filing all necessary dissolution documents with the SOS.
If you need to go through a nonstatutory conversion, you'll need expert legal assistance. However, in most cases, you should be able to avoid using this approach.
The tax consequences of converting your corporation to an LLC could be drastic. When the assets of your old corporation are transferred to your new LLC, you'll likely be taxed on this transfer. The corporation will be taxed for the sale or transfer of its assets ("liquidation"), and the shareholders, too, are taxed on the assets distributed to them.
While there could be some circumstances that'll substantially reduce the taxes involved in this type of conversion, in many cases the negative tax consequences will outweigh any potential advantages of the conversion. Before you start the conversion process, you should investigate closely how the conversion would materially benefit the business.
In general, the tax consequences associated with converting from a corporation to an LLC will be complicated. Ultimately, however, for any kind of corporation-to-LLC conversion, you should consult with an experienced tax adviser.
Here are some examples of states' conversion and merger laws. Every state has different requirements for converting a corporation to an LLC. Check your state's business laws for specific rules.
While some states have simple forms to fill out, other states don't provide any forms. It's simply up to the filer to create articles of conversion or articles of organization. If you need help drafting these documents, talk to a business attorney. They can draft these articles for you or review any documents you draft yourself.
California law allows for statutory conversions. To convert your corporation to a California LLC, you need to:
Plan of conversion. Your plan of conversion will need to include the terms and conditions of your conversion and how corporate shares will be converted to LLC membership interests. You'll also need to include a copy of your LLC's articles of organization. (Cal. Corp. Code § 3302 (2023).)
Vote by the directors and shareholders. State law requires the plan of conversion be approved by at least two-thirds of each class of shareholders regardless of whether those stockholders are entitled to vote. You can require a higher percentage for approval through your articles of incorporation or bylaws. In addition to approval by two-thirds of the shareholders, each shareholder that'll become a manager in the LLC needs to approve the conversion. (Cal. Corp. Code § 3302 (2023).)
You can file the conversion form online with the SOS bizfile Online or by mail.
Delaware law allows for statutory conversions. To convert your corporation to a Delaware LLC, you'll need to:
Delaware law requires that corporations give the shareholders at least 20 days notice of the meeting where the vote will take place. (Del. Code tit. 8, § 266 (2023).)
The Delaware Division of Corporations provides a combined form that includes both the certificate of conversion and the certificate of formation for your convenience. You should also attach a cover page with your contact information.
Florida law allows for statutory conversions. To convert your corporation to a Florida LLC, you'll need to prepare and approve a plan of conversion. After the plan is approved, you'll file a certificate of conversion and articles of organization with the Florida Department of State.
For more information, read about converting your corporation to an LLC in Florida.
New York doesn't allow statutory conversions. Instead, you'll need to use the statutory merger method. To convert your LLC to a New York corporation, you'll:
Plan of merger. The plan of merger needs to include the terms and conditions of the merger, including how the corporation shares will be converted to LLC membership interests along with basic information about the corporation and the merger. (N.Y. Bus. Corp. Law § 903 (2023).)
Vote by the corporation's directors and shareholders. The rules for shareholder approval of the plan 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. (N.Y. Bus. Corp. Law § 903 (2023).)
Vote by the LLC members. 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. (N.Y. Ltd. Liab. Co. Law § 1002 (2023).)
You can draft your own certificate of merger or complete the sample certificate provided by the DOS. If you create your own, you'll need to include a cover sheet that provides your contact information. You can mail your certificate to the Division of Corporations.
Regardless of which conversion method you choose, you still need to take care of all the tasks normally associated with creating a new LLC, such as:
Also, although various IRS guidance isn't entirely clear, you might need to obtain a new employer identification number (EIN) as part of the conversion process.
For more information, read our article about how to form an LLC.
One other key step in the conversion process is to make sure that no business contracts—like bank documents, loan agreements, and commercial leases—will be affected by your business's entity change. Check for any specific provisions in these documents, such as requirements to provide notice of the entity change.
Before you go through the official process of converting your corporation to an LLC, you should make sure it's the right choice. Talk to a business or corporate attorney about the benefits and drawbacks of the conversion. Because the tax implications of converting your corporation can be tricky and significant, you should also consider talking to a tax attorney or tax adviser as well.
If you do decide to convert your corporation to an LLC, check out your state's laws on converting corporations. These laws will likely be found under a title or chapter called "businesses and associations" or "corporations." Some states are more straightforward with their requirements than others. If you have questions about the proper procedure, talk to an attorney. They can walk you through the process, submit your conversion paperwork for you, and draft your articles of organization for your new LLC.
For a more complete discussion of the steps involved in forming an LLC, consult Form Your Own Limited Liability Company: Create an LLC in Any State, by Anthony Mancuso (Nolo). This book has guidance on choosing a management structure for your LLC and writing your articles of organization and operating agreement.