Should You Change Your LLC to a Corporation?

Changing your LLC (limited liability company) to a corporation can allow your company to issue stocks, be recognized as a business outside the U.S., and have the largest range of tax deductions. Let’s examine the pros and cons of changing LLC to corporation.

Why convert an LLC to a corporation?

Many entrepreneurs start their businesses as an LLC because it’s often considered the “best of both worlds” for a business entity. It offers limited liability protection for its owners (who are called “members”) without the rigid structure, reporting requirements, and double taxation of a corporation.

LLC vs. C Corp

But as the business grows, sometimes LLC members want to switch to a corporation for a variety of reasons, including:

Attracting investors. Because of its ability to buy and sell shares, it’s easier to raise money for a corporation. Buying stocks in a corporation is relatively simple, while the LLC structure doesn’t lend itself to making those kinds of ownership changes easily.

Recognized outside the U.S. If you want your company to do a lot of business internationally, you’ll struggle as an LLC because LLCs aren’t recognized outside of the U.S.

Has a life of its own. Often, an LLC is formed by a small number of people and, depending on the arrangements made in the operating agreement, it might not continue on if those members decide to leave, die, or become incapacitated. But a corporation is intended to continue regardless of how its leadership and owners change.

Most possible tax deductions: Corporations can take advantage of the most tax deductions, including deducting insurance premiums for employees. Depending on the size of your company, that could make a big difference.

Strongest level of liability protection. Both corporations and LLCs provide limited liability protection to their owners, meaning that, if someone sues the business or it goes into debt, the personal assets of the owners are usually safe. But a corporation’s liability protection is generally considered stronger, probably because the corporate structure and reporting requirements draw a firmer line between owner and business than an LLC.

Disadvantages of Converting Your LLC to a Corporation

Before you make the switch from LLC to corporation, consider the cons of converting from LLC to corporation:

Double taxation: The IRS taxes the profits of a C corporation vs LLC (the default form of corporation) twice. The corporation itself is first taxed on the profits, and then the individual shareholders are taxed on their personal tax returns for any profits they receive from the corporation.

But (as you know if you own an LLC), the IRS treats an LLC like a sole proprietorship or general partnership for tax purposes, meaning that the business itself isn’t taxed on the LLC’s profits. Instead, the individual LLC owners members only pay taxes on their share of the profits on their personal tax returns. This is called “pass-through taxation.”

You may be able to avoid double taxation as a corporation if you qualify to be taxed as an S corporation. S corporations (please see our What is an S Corp? page) have pass-through taxation, but they also have limits on the number and types of shareholders they can have. Plus, they tend to attract more scrutiny from the IRS.

Less management flexibility: Corporations have a strict structure requiring a board of directors who deal with managerial responsibilities and corporate officers who handle daily operations. It’s still legal in all states to have a one-person corporation, someone who wears all of those hats, but the corporation still has more government-established guidelines it must follow.

An LLC is much more flexible in how it’s managed. Any single member or group of members can manage it, making for a more centralized management structure.  In cases like this, the member-managers are heavily involved in running the business. However, if the members are primarily investors, they might opt to hire a manager to handle day-to-day operations, or appoint one or more members to fulfill that role.

More reporting requirements and red tape: Corporations require more paperwork than any other business structure. For example, the board of directors is required to meet at least once a year, and detailed minutes must be taken.

Tax Consequences of Converting LLC to Corporation

It’s important to consult a licensed tax professional before converting your LLC to a corporation to make sure any additional taxes don’t outweigh the benefits of switching. Remember, corporations are subject to double taxation, meaning both the company and its shareholders pay taxes on business profits.

Other Considerations

Depending on the state your business resides in, there are three types of conversion for your LLC to a corporation. The process for converting your LLC to a corporation generally consists of filing paperwork with the state and paying the appropriate filing fees. Paperwork may consist of updating your company name, EIN, permanent business address, Articles of Organization/Incorporation, business bank accounts, and your registered agent’s information.

Statutory Conversion

Statutory conversion is generally the easiest and most affordable option if your state allows it. This option allows business owners to transfer their LLC’s assets and liabilities without having to dissolve their business. The steps usually include:

1. Create a plan of conversion and have it approved by all LLC members.

2. File a Certificate of Conversion with the Secretary of State or equivalent state agency and pay a filing fee.

3. File any other legal documents required by the state.

After completing the filing process and paying any fees to the state, your assets and liabilities from your LLC should be directly transferred to your new corporation. Depending on the IRS guidelines, you may also need to acquire a new EIN for your company as part of the conversion process. It helps to work with a business attorney to ensure the correct documents are filed with the state.

Statutory Merger

If your state doesn’t allow a statutory conversion, a statutory merger is likely your next best option. Like a statutory conversion, a statutory merger allows all your LLC assets and liabilities to be transferred, but additional steps must be taken to ensure transfer. You must also:

1. Create a separate business entity for your corporation before you can transfer from your old LLC; and

2. Dissolve your old LLC after the transfer.

Nonstatutory Conversion

This method is the most costly and complicated way to convert your LLC to a corporation. Unlike statutory conversion and statutory merger, a nonstatutory conversion doesn’t automatically transfer assets and liabilities from your old LLC to your new corporation. To complete this type of conversion you must:

1. Form a new corporation.

2. Transfer LLC assets and liabilities to the new corporation.

3. Exchange LLC membership interests for corporate shares.

4. Formally liquidate and dissolve the LLC.

Because this method is a much more complicated process than the previous two methods, an attorney should be consulted for legal advice.

Additional Tasks

In addition to selecting how you wish to convert your LLC to a corporation, you must also complete the following:

• File documentation with the Secretary of State office that indicates your conversion from an LLC to a corporation (Articles of Incorporation can be filed for documentation and can be accepted as a conversion form in some states).
• Write corporate bylaws. These are the rules and policies that act as the lawbook for running your company.
• Conduct shareholder meetings.
• Elect corporate officers and appoint a board of directors.
• Hold an initial board meeting.
• Issue stock certificates.

Is an LLC or corporation best for you?

Deciding on the best business structure for your company can be confusing. To fully understand the difference between an LLC and a corporation, compare the two models for your business to see which unlocks the most benefits to help you grow your company.

Need more information on conversions? See below for additional resources:

• Can I Convert a Corporation Into an LLC?
• Should I Elect S Corp Status for my LLC?
• Becoming An LLC: A Smart Choice For The Self-Employed

We can help!

Our team of experts can guide you through all the steps to start your corporation today to ensure that your business is legally compliant with the state. Rather than guessing and hoping you have the right paperwork, have us provide and file all the documentation for you.