Looking for help on how to convert an LLC to a Corporation. We created a guide to walk you through step by step.
Guide On How To Convert An LLC To A Corporation
From lowering taxes to making stock compensation easier, there are several reasons why many business owners choose to convert their LLCs to a corporation. Once changing over to a corporation, the business also needs to decide to structure the entity as a C corporation or an S corporation.
Why Do Businesses Convert From An LLC to A Corporation
While an LLC (Limited Liability Company) structure often matches many businesses initially, it often doesn’t suit these companies forever. After some time, some businesses discover that operating as LLCs hinders the growth of the business for one or more reasons. This is fairly common, and those that are faced with this situation have the option to convert their companies from LLCs to corporations. However, there are a few important options and factors to consider before making this change.
Learn How To Form Your LLC here.
Benefits Of Converting From LLC To Corporation
A business owner might think about changing from an LLC to a Corporation for several reasons. Below are a few of the more common reasons:
– The Company Wants To Raise Money From Investors
Most investors usually prefer investing in corporations. This is because it is easier to sell and buy stakes in a corporation due to their transferable and defined ownership shares. Corporations can also issue separate classes of shares known as “preferred stock” that investors usually find attractive.
– The Business Wants To Undertake A Public Offering
If the business is planning to conduct public offerings of stock that is common, they have to be a corporation.
– Companies That Want To Issue Stock In The Form Of Compensation
Whether a business is interested in issuing its stock in the form of compensation to an organizer or initial investor, or regularly issuing these stocks to its employees to form a portion of regular compensation, these tasks are far easier to achieve as a Corporation when compared to an LLC.
– Businesses Wanting To Join Startup Accelerators
Incubators or startup accelerators often require equity and also require businesses to be incorporated.
– Companies Wanting To Lower Their Self-Employment Taxes
Members of an LLC have to pay Medicare and Social Security taxes according to their share of the company’s profits. With a corporation, the owners will receive payments similar to other employees, which means they are only liable for taxes according to their compensation amount. However, it is important to note that LLCs can choose a corporation taxation structure without having to convert to one.
When Should You Change From An LLC To A Corporation?
It is not always easy to say when you should be converting your LLC into a Corporation. But there are a few guidelines that may provide some help. For instance, now would be a good time to change over if you are planning public offerings of your stock in the near future. Another time that you may want to change over is when your self-employment tax as an owner has started to exceed the corporate tax amount the business would be paying if it was a corporation. Once you have crossed that threshold, your reasons start to disappear as to why you should be keeping the business as an LLC structure. However, keep in mind that an LLC can choose a corporation tax structure without switching from your LLC structure.
How to change the name of your LLC.
C Corporations Vs. S Corporations
C corporations and S corporations provide two different business structures. While they may share a few similarities, they do have a few significant differences you should know about.
Similarities
– LLP (Limited Liability Protection)
Similar to the LLCs, both C corporations and S corporations offer the owners of businesses Personal Liability Protection.
– THE FORMATION PROCESS
The C and S corporations require that the owners of the business file the formation documentation with the home state of the company.
– Basic Structure
At the same time, both C and S corporations have officers, directors, and shareholders and the businesses are able to issue shares from their profits to the shareholders in a dividend form according to the share numbers that are owned.
– Regulations And Rules
Both are required to hold director and shareholder meetings and retain minutes from these meetings, create bylaws, file annual reports, and issue stock.
Differences
– Taxation
Taxation is the main difference between C corporations and S corporations. At federal levels, C corporations have to pay tax as a separate entity with their personal corporate tax returns, and the shareholders are required to pay tax on the dividends that they have received from the stock of the company. S corporations, in contrast, are subjected to “pass-through” taxation. This means that S corporations themselves do not pay tax on their “income”, and the shareholders pay taxes on their personal portions of the business’s profits.
This can result in significantly lower tax payments for the owners of S corporations. At the same time, the taxes in each state can vary widely, which means S corporations often receive different tax treatments according to the state that the company is based in.
– Ownership Restrictions
S corporations will have more stringent regulations when it comes to ownership. For example, the shareholder number cannot exceed 100 members, and the owners can’t include C corporations, non-U.S. citizens, partnerships, LLCs, other S corporations, and other types of certain entities. Additionally, S corporations are only allowed to issue a single stock class while the C corporations are allowed to issue several classes of preferred and common shares.
The tight restrictions on the S corporation ownership often make it harder to sell the company or to obtain additional capital.
What Are The Required Qualifications To Convert From An LLC To A Corporation?
The main qualification required to switch an LLC into a Corporation is associated with ownership restrictions. For S corporation ownership, the company will need to match these qualifications when choosing this structure:
– The company must be domestic
– The business only has a single class of stock
– There are no more than 100 shareholders
– The business has no corporations, non-U.S. citizens, or certain types of other entities
How To Transition An LLC To A Corporation
When deciding to convert an LLC into a Corporation, there are different ways to achieve this transition depending on the state where the business is located. These include the following:
– Statutory Conversion
This is typically the least expensive and simplest way. A statutory conversion is also a new option that is not yet available in every state. While these processes may vary slightly from one state to the next (those that offer statutory conversion), it typically includes approving and preparing the conversion plan, followed by filing the relevant documentation with an appropriate regulatory state office.
This is typically the least expensive and simplest way. A statutory conversion is also a new option that is not yet available in every state. While these processes may vary slightly from one state to the next (those that offer statutory conversion), it typically includes approving and preparing the conversion plan, followed by filing the relevant documentation with an appropriate regulatory state office.
– Statutory Merger
With statutory mergers, the company has to first form the new corporation separately. From here the LLC members (who are now also the shareholders of the new corporation) have to first approve merging the two businesses and relinquish their LLC membership rights. The next step involves filing a certificate of this merger of the two companies, and other documentation with an appropriate regulatory state office. The last step involves dissolving the LLC.
Even though this method will also transfer liabilities and assets automatically like the statutory conversions, it is a lot more time-consuming and complex due to the additional steps required to first create the new corporation. However, it may be the only option in a state that does not provide statutory conversions.
– Non-Statutory Conversion
This option is regarded as the most expensive and most complicated way to convert an LLC into a Corporation since it is usually only used for specific rare situations that will also require legal assistance. Similar to statutory mergers, a new corporation must first be formed. From here, the business has to formally transfer liabilities, ownership interests, and assets with a separate agreement between the new corporation and the LLC. These are transfers that won’t occur automatically like the methods mentioned above. Finally, like statutory mergers, the business owners have to dissolve the LLC officially.
* IMPORTANT NOTE
The options mentioned above will be the same regardless of whether it is an S corporation or a C corporation, but the company will need to also file Form 2553 with the IRS (Internal Revenue Service) when converting to an S corporation.
Incorporation Responsibilities
If you have decided that your company needs to be converted into a Corporation, you will need to be aware of the new responsibilities you will be taking on that you did not have when you were an LLC owner. Incorporated businesses are required to choose directors directly from the shareholder group and these directors are then required to choose officers for the company. By law, these directors are also required to hold regular meetings and retain minutes from each meeting. Your new corporation is also required to issue stock or potentially even comply with extra financial-reporting requirements.