As a limited liability company ( LLC), many businessmen get their business off the ground.
This can make a lot of sense if you are the sole owner of a company or if you have only a few partners. Operating as an LLC provides flexibility for business owners.
From a tax perspective, the LLC could not be better: the income of the business is treated as the income of the owners. That’s right — you’re not paying separate business taxes if your company is an LLC. Alternatively, the corporation transfers taxable gains and uninsured losses on to the founders, who are all considered to be friends with nice people at the IRS.
Pretty straightforward, isn’t it?
But the time may come when you need to convert your LLC to C Corp. There are a few indicators that you need to think about converting to LLC to C Corp.In this article we will be studying about:
- Converting from an LLC to C Corp is an Excellent Idea Under 3 Circumstances
- A Few Downsides for LLC to C Corp Businesses LLC Partners Should Consider
- Avoid the Tax Penalty: Converting Your Business from LLC to C Corp
- Three Types of Conversion
- Additional Steps(LLC to C corp)
Converting from an LLC to C Corp is an Excellent Idea Under 3 Circumstances
1. You are a startup, and you would like to join the accelerator.
Accelerators or incubators that take equity also require the incorporation of their participants as a company. That’s because it makes it easy for you to offer equities to others, which is how accelerators make their money. Also, the integration tells accelerators that you’ve got your company ducks in a row.
2. You would like to raise venture capital
Venture capitalists tend to invest in C Corps, which allows investors to establish “preferred shares” of stock and have a clear legal framework that makes it easier for them to compare businesses side by side. But they still want to invest in Delaware C Corps because the state is especially favorable to businesses and their investors. More than 60 percent of Fortune 500 firms are folded into Delaware.
3. You want to give some equity to your employees
It’s easy to reserve shares in a corporation that your company can later distribute to employees. In the LLC, the partners own 100% of the company, so if you want to give equity to a non-partner employee, you will have to make that person a partner.
A Few Downsides for LLC to C Corp Businesses LLC Partners Should Consider
C Corp, unlike the LLC, has to pay taxes. When the organization then distributes its profits (to be paid by its owners, employees, and investors), each individual has to pay income taxes on those funds. That might feel like a big shift if your company was operating as an LLC to C corp — you’re suddenly going to pay taxes twice.
The process of converting the LLC to a C corp corporation can be complicated. It all depends on the state of your LLC. Some states, such as California, require fast-track transfers that allow you to move the LLC to a company in another state — usually Delaware. In other countries, the process can be even more complicated.
There is one more thing to be aware of: a tax penalty that you can easily avoid by filing your paperwork on time.
Avoid the Tax Penalty: Converting Your Business from LLC to C Corp
When you find yourself ready to switch from a relationship to a company, your partners may want to pay attention to a particular requirement:
The IRS wants you to file a tax return for the LLC as soon as it ceases to exist.
LLC partners have three and a half months to file a return and pay for what is known as a short tax year. Otherwise, in addition to income taxes, the spouses will be on the hook for $195 a month each.
You may be able to simply convert all the assets and liabilities of your LLC to your new C Corp. In accordance with Section 351 of the IRS Code, this is called a tax-free investment and there can be no profits or losses. If that is the case, you ‘re not going to have to pay taxes.
But if your LLC contributes more liabilities than assets to the new C Corp, you would have to pay taxes. For example, say your LLC contributes $50,000 in assets (cash, inventory, accounts receivable) and $70,000 in liabilities (accredited expenses, debts). Essentially, your LLC partners have just unloaded $20,000 in debt to the new C Corp.
For the IRS, the $20,000 is income, and the LLC members will have to pay income taxes on that as soon as possible.
$195 a month is a lot to pay for losing the paperwork. Don’t let it happen to you, man!
Three Types of Conversion
1. A statutory conversion is a relatively new, streamlined procedure, available in many states, that allows you to convert your LLC to C corp a corporation by filing a few forms with the Secretary of State. Every State that permits statutory conversions shall have its own unique forms and laws. In general, however, the measures for statutory conversion include:
Prepare a conversion proposal and get it approved by members of the LLC;
File the certificate of conversion and, if necessary, the LLC certificate of formation and other legally required documents with the Secretary of State.
Although there are significant legal differences between legislative conversion and other forms of conversion, the functional results are the same: people who were LLC members are now shareholders of your new company, the assets and liabilities of your LLC are now assets and liabilities of your new corporation, and your LLC ceases to exist. A crucial point with regard to statutory transitions is that all such effects occur automatically from the application of the law rather than by separate, structured agreements on exchanges of LLC interest on shares and transfers of assets and liabilities, often without additional filings with the Secretary of State.
2. The legislative merger is more complicated than the statutory conversion. However, if your state does not allow for legislative conversions, you are likely to use this form. While specific details vary from state to state, the basic steps of a statutory merger usually include:
Create a new company (meaning your LLC members will now be corporate shareholders)
Have the members of the LLC vote to approve the merger both as members of the LLC and as shareholders of the corporation
Have the members of the LLC formally exchange their membership rights for shares in the corporation;
Fill a certificate of merger and/or other legally required documents with the Secretary of State.
3. Non-statutory conversion is usually the most difficult and costly way to convert from an LLC to a C corp. Quite briefly, the main steps are as follows:
- Creating a new company
- Move the properties and liabilities of your LLC formally to the company
- Formally allow for the exchange of interests in the membership of LLC for the shares of the corporation;
- Otherwise, it would officially liquidate and disband the company.
Additional Steps(LLC to C corp)
Irrespective of the method you use to change the legal form of your LLC to C corp, you will still need to take care of all the tasks normally associated with the creation of a new corporation, such as:
Filing a collection of articles of incorporation or an equivalent document with the Secretary of State, including an indication that you are converting from the LLC (in some states, the articles of incorporation the serve as a form of conversion)
- Creation of corporate by-laws
- Choosing corporate officers and appointing corporate directors
- Having an initial meeting of the Board;
- Issue of stock certificates.
Finally, you will also need to ensure that no business contracts or agreements, such as bank documents, leases, licenses, and insurance, are nullified by changing your business entity from an LLC to C corp.
Yeah, California. California legislation provides for constitutional conversions. As stated in the California Secretary of State instruction document, “California limited liability company can be transformed into a California stock corporation by filing Articles of incorporation containing a conversion declaration.” To convert your Callifornia LLC to a California corporation, your key tasks will be to prepare and approve a conversion plan and then to file a slightly different conversion plan.
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