Since creating a limited liability company (LLC) is an easy process in most states, many business owners opt for this structure when establishing their company. But sometimes, a company's goals outgrow the LLC structure, and the owners want to convert their LLC into a corporation.
Conversion requires more paperwork and has tax repercussions and additional filing requirements. Here is some guidance to help you evaluate whether conversion into a corporation is the best move for your LLC.
Why convert an LLC into a corporation?
You might want to convert your LLC into a corporation for practical reasons.
“If your company is exhibiting significant growth, converting from an LLC to a corporation will give you the flexibility to allocate some profits to qualify for a lower income-tax bracket," says Paul Sundin, a CPA and tax strategist for Emparion.
If you plan to offer stock options to employees, this benefit is available only through a corporation. In addition, “incorporating has a positive effect on a company's legal liability," Sundin says. “As an LLC, getting sued would mean risking your personal assets if you lose a case. A corporation, however, is only liable for the assets owned by the company."
Advantages of converting
According to Dan Nguyen, a California business attorney, here are some additional benefits of converting an LLC into a corporation.
- In a corporation, shares of corporate stock are freely transferable by sale, gift, or pledge. In addition, the “transfer of stock does not affect the separate legal status of a corporation," Nguyen says.
- It is easier to raise capital and implement employee incentive plans, and corporations can deduct some health insurance and fringe benefits.
- The management structure is well-established in a corporation.
- In certain states, like California, some tax benefits are available to corporations that aren't available to LLCs.
Disadvantages of converting
One of the biggest disadvantages of conversion is that a “corporation is subject to double taxation—with both the company and its shareholders paying taxes on profits," Sundin says. However, if your business qualifies as an S corporation, profits pass through to shareholders' personal tax returns, and the corporation avoids double taxation.
Keep in mind that the cost of certain maintenance items increases in a corporate structure, such as the necessity of recording minutes of meetings as well as additional tax-filing requirements. The management structure in a corporation is less flexible. An LLC is simpler to operate.
What's the right decision?
It depends. As an LLC owner, you need to evaluate the company's profits, how fast it is growing, and whether the current structure provides the protections you need, such as greater liability protection and tax savings. Contact an accountant or attorney to determine the best course of action.
How do you convert an LLC into a corporation?
In general, three types of conversions are possible, depending on your state.
Many states already have statutes in place that make a quick-status conversion simple and straightforward. You fill out some forms with your company name, Employer Identification Number, address, and the registered agent's information and submit these to the secretary of state.
Through this process, you merge your existing LLC into a new corporation. Here are the steps:
- Create a new corporation.
- Take a vote among the LLC members approving the change from members to stockholders.
- Change membership rights to agreed shares in the corporation.
- File a certificate of merger and other required documents with the secretary of state.
This is the most expensive and difficult process of changing entities since it includes asset liquidation and dissolution of the existing company to create a new one. The new corporation absorbs all assets and liabilities.