If you’re thinking of converting the legal form of your small business from a corporation to a Texas LLC, you should be aware of some basic facts regarding the Texas's business-entity conversion process. Because the tax consequences can be significant, you should consult with a tax adviser before undertaking any conversion. For information on business entity conversion rules in other states, check Nolo’s 50-State Guide to Converting a Corporation to an LLC.
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. Instead, we’ll try to keep matters as simple as possible, focusing mainly on the general rules of Texas’s business-entity conversion statute as it applies to closely-held Texas corporations converting to multi-member LLCs (the most common type of conversion).
In Texas, 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 short forms with the Secretary of State. This procedure, technically known as “statutory conversion,” will automatically convert your corporation to an LLC and automatically transfer your corporation’s assets and liabilities to that new LLC. Unlike other methods of conversion, only one business entity is involved, and you do not need to separately form an LLC before the conversion can occur; as a result of the statutory conversion, your corporation becomes an LLC, and so there is no need for a separate process to dissolve the corporation. The procedure is codified primarily in Sections 10.101 through 10.109 of the Texas Business Organizations Code (BOC). If you’re looking at the statute, keep in mind that Texas—using terminology common in many states—refers generically to a “converting entity” (which will be the corporation) and a “converted entity” (which will be the LLC).
To convert your Texas corporation to a Texas LLC, you need to:
The plan of conversion is a relatively simple statement of key elements of the conversion; at a minimum, it must provide:
Though non-Texas business entities are not covered in this article, do be aware that, under Texas law, plans of conversion for such entities require a few additional items of information. For details, check BOC § 10.103.
It does not appear that the Secretary of State currently provides a sample plan of conversion. Depending on your level of expertise, it may be advisable to seek the assistance of an attorney in preparing this document. By default, the Texas conversion statute requires approval of the plan of conversion by at least two-thirds of each class of shares for a corporation. However, the statute also lays out several possible alternative voting requirements for approving a plan; for more details, check BOC § § 21.453, 21.457, 21.458, and 21.459.
The plan of conversion may, but need not, be attached to the certificate of conversion you file with the Secretary of State; however, if you do attach the plan of conversion to the certificate of conversion, the Secretary of State asks that the certificate of formation be included within the plan of conversion, for example as an exhibit.
The Secretary of State is also quite specific that you need to attach the correct form of tax account certificate to your certificate of conversion; namely, form #05-305, which is not available from a website, but must be obtained directly from a representative of the Texas Comptroller of Public Accounts.
A blank certificate of conversion for a corporation converting to a Texas LLC, Form 632, including instructions, is available online from the Secretary of State.
A blank certificate of formation for your new Texas LLC, Form 205, is also available online from the Secretary of State. Your certificate of formation should be filed with the certificate of conversion; it must include a statement that the LLC is being formed pursuant to a plan of conversion, as well as information regarding the prior legal form of your business. Be aware that the blank formation certificate available online does not include specific spaces for the latter statements, and so they should be added in the “Supplemental Provisions” section of the form.
The total filing fee for this process is currently $600, which includes $300 to file the certificate of conversion and $300 to file the certificate of formation.
Keep in mind that Texas’s conversion statute makes clear not only that rights and interests in the corporation’s property, and corporate debts and liabilities, are automatically transferred to the new LLC, but also that the rights of creditors against the corporation continue against the new LLC, and all legal actions against the corporation may continue against the new LLC without the need to substitute any parties. For more information, check BOC § 10.106.
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. 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).
Finally, you also will need to make sure that no business contracts or agreements, such as bank documents, leases, licenses, and insurance, will be nullified by the entity change.
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 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 advisor.
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, check Nolo’s 50-State Guide to Converting a Corporation to an LLC.