Guide to Converting an LLC to a Corporation

If you started a business as an LLC and later find that a corporation is a better match, you may be wondering how to convert your business structure.

This guide covers why businesses convert from an LLC to a corporation, how a conversion takes place, and the steps involved. While the exact requirements and steps involved vary by business, this general guidance is a useful starting point.

Difference between a C Corporation and an S Corporation

The main difference between a C corporation and an S corporation is how they are taxed.

When you form a corporation by filing Articles of Incorporation with the state, it is generally taxed as a C corporation by default. A C corporation pays taxes on its profits. If those profits are later paid to shareholders as dividends, the shareholders may also pay taxes on that income. This is often called “double taxation.”

An S corporation is taxed differently. It generally doesn’t pay federal income tax at the corporate level. Instead, the company’s income, losses, and deductions pass through to the shareholders, who report them on their personal tax returns. This is known as pass-through taxation.

To be taxed as an S corporation, a business must qualify and file Form 2553 with the IRS. S corporations have specific requirements, including:

• No more than 100 shareholders
• Shareholders must meet certain eligibility requirements
• Partnerships and corporations generally can’t be shareholders
• Only one class of stock is allowed

These restrictions can make S corporation status less suitable for businesses that plan to raise money from institutional investors, such as venture capital firms.

Good to know: An LLC doesn’t have to convert to a corporation to elect S corporation or C corporation tax treatment. The business can remain an LLC while changing how it is taxed. To elect S corporation tax status, the LLC must meet IRS eligibility requirements and file Form 2553.

Reason to Convert to a Corporation

As your business grows, there are several reasons why converting from an LLC to a corporation may make sense.

• Attracting investors: Corporations, particularly C corporations, can be more attractive to outside investors because they make it easier to issue shares and structure investments. This can be especially important if you plan to seek funding from venture capital firms or other institutional investors.
• More stock options: C corporations can issue different types of stock, including common and preferred shares.
  • Common stock is the most common type of ownership. Founders and employees often receive common shares, which typically come with voting rights and can increase in value as the company grows.
  • Preferred stock gives shareholders certain advantages over common stockholders. For example, they may receive dividends first or have priority over common shareholders if the company is sold or closes. Preferred shareholders typically have fewer voting rights.
• Attracting Talent: C corporations can offer employees stock options, giving them the opportunity to share in the company’s success. This can help your business attract top talent and motivate employees to contribute to the company’s growth.
• Preparing for IPO: If you plan to take your company public, a C corporation is typically the preferred structure. It allows you to issue stock to the public and meet the requirements of an IPO.

Key Considerations Before Converting

Before converting your LLC to a C corporation, it’s helpful to understand how the change could affect your taxes and ongoing responsibilities:

• Taxes: C corporations pay corporate income tax on their profits. Shareholders may also pay taxes on dividends they receive, which is often referred to as “double taxation.” Depending on your plans for the business, including whether you expect to reinvest profits, this may or may not be a significant concern.
  
  The timing of your conversion can also affect your tax filings. For example, converting during the year may mean filing separate tax returns for the periods before and after the conversion. A tax professional can help you understand what will apply to your business.
  
  Ongoing requirements: Corporations also have more formal requirements than LLCs. Depending on your state, these may include:
  • Appointing a board of directors and corporate officers
  • Holding shareholder and board meetings
  • Keeping minutes and written records of important corporate decisions

These additional steps take some work, but understanding them upfront can help you decide whether converting to a C corporation makes sense for your business.

Statutory Conversion vs. Statutory Merger

There are a few ways to convert an LLC or partnership to a C corporation. Which option is available to you will depend on the state where your business was formed.

• Statutory conversion: This is often the simplest option. If your state allows it, you can change your existing business from one entity type to another by approving a conversion plan and filing the required documents with the state.
• Statutory merger: If your state doesn’t allow statutory conversions, you may be able to use a merger instead. This involves forming a new corporation and merging your existing LLC or partnership into it. The LLC members or partners then become shareholders in the corporation. Because you’re creating a new entity and completing a merger, this option generally involves more paperwork.
• Non-statutory conversion: Another option is to form a new corporation, transfer the existing business’s assets to it, and then dissolve the old business. This approach is typically more complex and less commonly used.

Conversion options and filing requirements vary by state. Before moving forward, check what your state allows and what forms and other steps are required to complete the change properly.

How to Convert from an LLC to a Corporation

Corporations are generally taxed as C corporations by default, whether they are newly formed or converted from another business entity. You typically convert your LLC to a C corporation through a statutory conversion or statutory merger, depending on what the state allows.

Becoming an S corporation requires an additional step. Once the conversion is complete, your corporation must elect S corporation tax status with the IRS.

The process and requirements vary by state, so it’s important to work with an experienced business professional to make sure all requirements are met.

Statutory Conversion

A statutory conversion is typically the simplest path. In states that allow it, an LLC can convert directly to a corporation by filing the required conversion documents with the Secretary of State. The steps are:

1. Review your governing documents: Review your LLC Operating Agreement for any conversion requirements, voting rules, or restrictions.
2. Prepare and approve a plan of conversion: Prepare a Plan of Conversion that outlines the terms of the conversion, including how LLC membership interests will convert into corporate shares. Obtain approval from the LLC members as required by the Operating Agreement or state law.
3. Obtain required tax and regulatory clearances: Depending on the state, you may need tax clearance certificates, a certificate of good standing, or other approvals.
4. File the conversion documents with the state: File the required conversion documents with the Secretary of State. If your LLC is registered to do business in other states, you may also need to update those registrations to reflect the conversion.

Statutory Merger

A statutory merger follows many of the same steps as a statutory conversion, with two key differences: you must first form a new corporation and prepare a merger agreement instead of a conversion plan. Here’s the process:

1. Form a new corporation: Prepare and file Articles of Incorporation with the Secretary of State.
2. Prepare a merger agreement: Create an agreement that outlines the terms of the merger.
3. Obtain board and member approval: Have the new corporation’s board approve the merger, then submit it to the LLC members for approval based on the voting requirements in the Operating Agreement or state law.
4. Obtain required tax and regulatory clearances: As with a statutory conversion, you may need tax clearance certificates, a certificate of good standing, or other approvals.
5. File a certificate of merger with the state: File a certificate of merger or other required documents with the Secretary of State.
6. Update registrations in other states: If your LLC is registered to do business in other states, you’ll generally need to withdraw those registrations. If the new corporation continues doing business in those states, you may need to register there as a foreign corporation.

Electing S Corporation Tax Status After Converting

Once the conversion is complete, your corporation can elect S corporation tax status by filing Form 2553 (Election by a Small Business Corporation) with the IRS. All shareholders must agree to the election.

You must file the form within a specific timeframe. Generally, this means no more than two months and 15 days after the start of the tax year in which the election will take effect.

Your corporation must also meet IRS eligibility requirements, including having no more than 100 shareholders and only one class of stock.

If your corporation doesn’t qualify or you choose not to make the S corporation election, it will be taxed as a C corporation by default.

Important Post-Conversion Steps

Regardless of the conversion method you used, your new corporation must follow standard corporate requirements. These help maintain the corporation as a separate legal entity and protect shareholders’ limited liability.

Key steps may include:

Set up your corporate governance

• Adopt corporate bylaws
• Issue stock to shareholders
• Hold required meetings and provide proper notice
• Elect directors or confirm existing directors
• Keep minutes and other corporate records

Check whether you need a new EIN

This can depend on how the conversion was completed. A statutory merger generally creates a new corporation that needs a new EIN. For a statutory conversion, consider checking with a tax professional to determine whether a new EIN is required.

Update business records and accounts

Make sure your new corporate status is reflected in:

• Business licenses and permits
• DBA (fictitious business name) filings
• Bank accounts and other financial accounts
• Vendor, customer, and other contracts
• Insurance policies

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