Change Corporation To LLC: Everything You Need to Know
To change a corporation to an LLC is simple in most states, and forming a Limited Liability Company or LLC is a smart choice for many small businesses. 3 min read
2. Differences Between Corporations and LLCs
3. Benefits of an LLC Over a Corporation
4. Advantages of Converting From a Corporation to an LLC
5. Disadvantages of Converting From a Corporation to an LLC
To change a corporation to an LLC is simple in most states, and forming a Limited Liability Company or LLC is a smart choice for many small businesses. The tax factors of converting are not as simple, though. And, the conversion can result in a large tax bill.
Converting a Corporation to a Limited Liability Company
Pass-through federal taxation is one major advantage of an LLC over a corporation. The reason this is an advantage is that profits of a corporation are taxed two times. First, when the company earns the money and again, when the profits are passed to the owners in the form of wages. When an LLC earns profits, they are not taxed. So, when you convert from a corporation to an LLC without dissolving your corporation, the IRS requires you to file a document called a Certificate of Conversion. You must file it with the state agency that registers business organizations.
There are a number of reasons that corporations wish to change the form of their organization to an LLC, including concentrating the ownership into a smaller group or to take advantage of an LLC's unique tax options. However, you can't just fill out a form to change a corporation to an LLC. Plus, there are advantages to corporations, too.
First, you must fully dissolve the corporation. Then, you form a new LLC, and all assets are transferred to the new company before the transition is complete. You need to know the positives of converting a corporation to an LLC and the cost of changing from a corporation to know if it makes sense for your business.
Differences Between Corporations and LLCs
The protection of personal liability for business obligations is the same whether you're doing business as an LLC or corporation. The way corporations and LLCs are managed, owned, and taxed is different. LLCs are more flexible with taxes and offer owners more options than corporations.
Benefits of an LLC Over a Corporation
- Corporations need to have a board of directors, and LLCs can choose their management structure.
- The profits and losses are distributed among owners of a corporation based on how many shares are owned, while LLC members may distribute losses and profits in any way they choose.
- The tax flexibility and recordkeeping requirements are more flexible with LLCs than corporations.
Advantages of Converting From a Corporation to an LLC
There are numerous reasons that companies may choose to switch from a corporation to an LLC. Below are a few:
1. Take advantage of pass-through taxes.
- There are advantages to pass-through taxation. The IRS taxes the money corporations make when the company earns money, and then, owners pay taxes again on the money they make.
- Some corporations are able to avoid being taxed twice by conducting business as an S corporation.
2. Gain flexibility.
- In a corporation, you receive profits and losses in proportion to the number of shares you own.
- Members of an LLC divide profits in whatever way they choose.
- Losses and profits of an LLC do not have to be split among members based on their ownership.
3. Gain management flexibility.
- The board of director, officer, and shareholder structure might not work for small businesses.
- An LLC allows you increased flexibility.
- Corporations have a strict structure.
4. Avoid paperwork.
- Switching to an LLC might save you from all of that corporate paperwork.
- Corporations have to file required paperwork like meeting minutes.
Disadvantages of Converting From a Corporation to an LLC
In addition to there being advantages to converting a corporation to an LLC, there are some disadvantages you should be aware of listed below:
1. The business may pay more taxes.
- The business is taxed on assets and gains on assets which have appreciated since the business was acquired.
- The business must pay the tax even if they do not actually receive the money.
- When a corporation converts to an LLC, the business may be required to pay taxes at the corporate and at the individual level.
- Typically, when an S corporation converts the business, they will likely only pay taxes at the individual shareholder level.
2. Investors are not as interested in LLCs.
- Pretty much all investors, including angel investors, want to invest in corporations, not in LLCs.
- If you switch from a corporation to an LLC, you may have to change back to pursue funding.
3. Transferring membership in an LLC is more difficult.
4. Corporations are better for giving employees stock incentives.
So, there are important advantages for converting your business from a corporation to an LLC. However, there are also drawbacks, especially with taxes.
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