While it may not happen all the time, it's not unusual for the shareholders of a corporation to discuss changing the corporation to an LLC, or limited liability company. There are a number of reasons why shareholders might decide such a change in business structure is beneficial.
Corporation vs. LLC
A corporate name is required to include "Inc." or "Incorporated" or some other signifier that the entity is a corporation, while an LLC name must include "LLC" or another such indicator that it is a limited liability company. However, there are more differences between the two entities than the way their names are styled.
One common reason for changing a corporation to an LLC is to avoid double taxation. A corporation faces double taxation because the income it earns is taxed first within its hands, and then a second time in the hands of its shareholders.
An LLC, on the other hand, offers "pass-through taxation" (unless it elects to be taxed as a corporation); it is a pass-through entity, which means it doesn't get taxed on the income it earns. Instead, this income "passes through" to its members, where it then gets taxed.
There are other reasons why the LLC form of business structure may be more beneficial than the incorporated form. For one, an LLC offers a more flexible management structure, which the shareholders of your corporation may find desirable, and profits are not required to be distributed according to ownership percentages.
Additionally, corporations also must meet more stringent compliance requirements, such as holding annual meetings and keeping proper minutes of meetings. While it's often recommended that LLCs do the same, such formalities are not actual requirements.
Changing from Corporation to LLC—the Traditional Route
Changing a corporation to an LLC is not an impossible task, but the traditional way of doing so can be quite complicated and expensive, as it requires you to first form a new LLC, then to transfer the assets and liabilities of the corporation to the new LLC and exchange shareholders' shares for LLC memberships and then, finally, to dissolve the corporation.
Fortunately, it may be possible to convert a corporation to an LLC without going through this more complicated procedure. Also review: S Corp vs. LLC
Taking a More Streamlined Approach, If Your State Allows
If you feel there are benefits to converting your corporation to an LLC, is it possible to do so without dissolving the corporation?
Many states provide for a business entity conversion process that is both less complicated and cheaper than the traditional method. Using such a conversion process to change corporation to LLC does not require you to dissolve your corporation.
Instead, rather than your forming an LLC, the corporation is converted to an LLC. Additionally, corporate assets and liabilities are automatically transferred over to the new LLC.
However, there are some states that do not offer this more streamlined conversion process. You will need to check with the agency responsible for corporations in the state in which your corporation was formed and see if a conversion process is available.
In doing your research, you may discover that your state provides for a merger process rather than a conversion process. While a merger process is not as complicated as the traditional way of changing your corporation to an LLC—for example, a merger will also automatically transfer your corporation's assets and liabilities to the new LLC—you will be dealing with two separate entities: the new LLC that you must first form, as well as the corporation, and, once the process is complete, you will then need to dissolve the corporation.
If the state in which your corporation was formed does not provide a business entity conversion process, and you still wish to change your corporation to an LLC, you will, unfortunately, have to go through the more traditional, costly route that involves a number of formal steps, including the dissolution of your corporation.
Following the Right Steps for Conversion
Because each state that offers a business entity conversion process will have different requirements, it's not possible within the scope of this article to touch on everything you'll need to do; however, in general, you'll likely have to do the following:
- Plan of Conversion. Most—but not all—states that provide for a conversion process require you to prepare a plan of conversion. The contents of such a plan will vary depending on your state, so it's important to check the requirements if such a plan is required. Some states may also require the corporation's board of directors to adopt the plan before presenting it to the shareholders for approval. You will need to comply with whatever steps regarding the plan of conversion are required under your state's laws.
- Approval. The plan of conversion, if one is required, will need to be approved by a majority of the corporation's shareholders. If a plan is not required, then a majority of shareholders will have to approve the conversion itself; for example, state laws may require shareholders to approve a resolution of the board of directors to convert the corporation to an LLC. If the articles of incorporation or corporate bylaws provide for a specified majority for any vote, then the approval of that majority will be required.
- Filing of Required Documents. In addition to the filing of a conversion document or form—known by various names, including certificate of conversion, articles of conversion, and statement of conversion—you may also be required to file other documents, such as articles of organization for the new LLC, and/or a certificate of formation for the LLC. The filing fees for the conversion process also vary from state to state. When you obtain a conversion of your corporation to an LLC through your state's business entity conversion process, the corporation's assets and liabilities will be automatically transferred to the LLC.
While most states offer this more simplified conversion process that lets you convert your corporation to an LLC without going through the formal steps to dissolve it, you should be aware that the tax consequences of changing your business structure from a corporation to an LLC can be extremely complicated and potentially quite onerous, regardless of what process you use to convert your corporation. Therefore, It's highly recommended that you consult with a qualified tax advisor before embarking on the conversion of your corporation to an LLC.