If the owners of an LLC agree, an LLC can convert to a corporation. This could result in more paperwork and taxes, but what are the benefits?
Converting An LLC to a Corporation Can Help To Bring in Investors and Lower Taxes
Convert your LLC into a corporation so that you can simplify stock compensation matters and lower your taxes. When you do so, you need to be clear about whether you want your company structured as an S corporation or as a C corporation.
Why Convert From LLC to Corporation?
When you set up a business initially, you may find that the limited liability company (LLC) route is best, but this may not be suitable for you in the long term. Once you have operated a business as an LLC for some time, you may actually find that it hinders the growth of your business for many different reasons. This is quite a common occurrence and faced with this situation, you need to consider transiting your business from being an LLC to becoming a corporation. You, however, need to consider a number of important options and factors before you initiate this change. Decide on this step of changing your company from an LLC to a corporation only after you have enough information, such as you can get from this article.
Reasons for This Conversion
There are a number of reasons, why, you, as a business owner will need to consider changing your company to a corporation from its present status as an LLC. The most common of these are:
You need investors to invest in your company. Most investors prefer to put their money into corporations. Corporations have defined shares whose ownership is transferable, and this makes it easier for them to buy or sell their stakes. Some corporations issue a class of preferred stock, and investors find them attractive.
If you plan to undertake a public offering at some time and offer common stock to the public, you need to first look at the forming of a corporation.
You need to issue stock as compensation. Stock is often offered as compensation to organizers or investors and also sometimes to employees. You can do this easily if you are a corporation, but not as easy if you remain an LLC.
Joining a startup accelerator. Incubators or startup accelerators ask for equity for their services and this becomes easier if your company is incorporated.
Lowering of self-employed taxes. Members of an LLC need to pay taxes, like Social Security and Medicare, based on the share they have of the profits from the company. In a corporation, owners are compensated just like all other employees and only need to pay taxes on this compensation. LLCs, however, can choose to be taxed as corporations without any conversion.
The Right Time to Make the Change
It is not easy to pinpoint the right moment for converting an LLC to a corporation, but you will be helped if you follow certain guidelines. If you are planning to list your stock in a public offering, you will need to make the change from LLC to the corporation. If your self-employment tax is more than what your company would pay as corporation tax, it makes for one more reason for changing from an LLC to a corporation. Keep in mind, however, that you can always choose to pay your taxes as a corporation, without making this change.
S Corporations Versus C Corporations
Each corporation, whether S or C, has its own distinct business structure. There are many similarities in these structures, but also significant differences.
Similarities
– Limited Liability Protection: Both S and C corporations offer their owners personal liability protection, just like LLCs do
– Process of Formation: Business owners are required to file documents dealing with the formation with the home state the company is in.
– Basic Structure: Both types of corporations will have directors, officers and shareholders, and the corporation can offer dividends to shareholders from the profit, based on the number of shares that they own.
– Rules and Regulations: Both corporations need to hold meetings of shareholders as well as of directors, the minute these meetings, issue stock, create any needed bylaws, and file reports annually.
Differences
– Taxation: This is the area where there is a big difference between S and C corporations. C corporations, at the federal level, need to pay taxes and file returns as a corporation, while their shareholders will have to pay taxes on any dividends they receive. Contrast this to the “pass-through” taxation that S corporations are subjected to. So, the S corporation by itself does not pay any taxes on the income that it has, while shareholders pay tax on their share of the company’s profits. This results, in quite often much lower taxes for S corporation owners. State taxes vary widely and S corporations will not receive similar treatment in each state.
– Restrictions on Ownership: The regulations for ownership in S corporations are much stricter. Ownership is restricted to 100 shareholders and owners must all be U.S. citizens. Other C corporations, S corporations, partnerships and LLCs, as well as some other entities, are barred from ownership in an S corporation. S corporations are allowed to issue only one form of stock, while C corporations have the freedom of deciding the class of shares that they issue, both common and preferred. S corporations have more restrictions, and this can make it difficult to sell them, as well as to raise capital.
Qualifying for Changing Your Company From LLC to Corporation
Ownership restrictions make for the primary qualification for converting a company from LLC to a corporation. S corporations have many restrictions on ownership, and you need to qualify if you choose this structure for your conversion.
- A company must be a domestic one
- Shareholders are limited to 100
- One class of stock
- All shareholders must be U.S. citizens, while none of them must be a corporation or other entity that is barred from such ownership
Transiting From LLC to Corporation – Three ways
There are a number of ways you can make the change from an LLC to a corporation, but this can depend on your state. They include:
Statutory Conversion
This method is the simplest one that is not expensive but is not available in all states. The process of statutory conversion varies from state to state, but in general needs, you to prepare a plan of conversion and fill-in in the relevant forms with the right state regulatory office. All assets and liabilities of an LLC are transferred to the corporation, and all members in the LLC become shareholders in the corporation, a process that happens automatically, and this is characteristic of statutory conversion. So, you do not need to carry out any other paperwork that the other methods have.
Statutory Merger
You first need to separately form a corporation if you desire to go in for a statutory merger. Next, the members of the LLC, who are now shareholders in the new corporation, will have to approve this merger and give up their right to LLC membership, Companies then have to file certificates of the merger as well as complete any other needed paperwork that the appropriate state regulatory office may require. The LLC then needs to be dissolved. Just like in a statutory conversion, all transfers of assets and liabilities are automatic, but the difficulties in this method come from the complicated and time consuming additional steps that require a corporation to be first created. It becomes an option when a state does not offer statutory conversions.
Non-statutory Conversions
This method is not only the most complicated but also the most expensive for converting an LLC to a corporation. It is a method used rarely and does need the assistance of legal experts. Just as in a statutory merger, the first step is to form a corporation. You then need to formally transfer the assets and liabilities from the LLC to the corporation through separate agreements between the LLC and the new corporation. This transfer is not automatic, as it is in the other methods. Just as in a statutory merger, you then have to dissolve the LLC officially.
Important Note
These options are the same for both C ad S corporations, but in the case of converting to an S corporation, you will have to additionally file Form 2553 with the IRS.
Incorporation Brings New Responsibilities
You may have decided that it is best for your business to convert from being an LLC to being a corporation. But you must be aware, that with the advantages this business structure can bring, it will also add to your responsibilities, some of which you may not have had as the owner of an LLC. You have to elect directors from among your shareholders, and then select officers for the corporation. Under laws in place, director’s meetings have to be scheduled regularly and these meetings minuted. Stock in the new company has to be issued, and you may also be required to comply with any legal requirements for financial reporting.