Key Takeaways

  • Converting a California S Corporation to an LLC typically involves either a statutory conversion or a merger.
  • A Certificate of Conversion and Articles of Organization must be filed with the California Secretary of State.
  • Shareholder approval is required, and dissolution procedures must comply with state and IRS requirements.
  • Tax consequences include possible capital gains taxes, as the IRS views the transaction as a liquidation.
  • Post-conversion steps include updating licenses, tax registrations, and legal agreements.
  • LLCs offer more operational flexibility and fewer formalities than S Corporations.
  • Legal and tax guidance is highly recommended due to complexity and potential liabilities.

To convert an S-corp to an LLC, you will need to take key steps based on your state's regulations:

  1. Obtain shareholder authorization as required by your state.
  2. File a Certificate of Conversion or, in some states, form an LLC and complete a merger.

Converting S-Corp to LLC

Both limited liability companies (LLCs) and S-corporations operate with limited liability, and neither are taxed at the federal level. There are some exceptions in S-corporations regarding passive income. 

There are several benefits associated with forming an LLC, including the following:

  • Simplified operations
  • A reduction in formalities
  • Flexible tax options

In comparison to S-corporations, LLCs are easier to manage and are less formal in terms of recordkeeping. There is also greater flexibility among shareholders. While S-corporations can have no more than 75 owners, LLCs can have an unlimited number of shareholders. 

If you are currently operating an S-corporation and would like to convert to an LLC, it is certainly possible. Depending on your state, you will need to do one of two things:

  • File for a merger.
  • Notify the state that your corporation will be changing its status.

In many states, you will be required to complete a form and file with the secretary of state. In other cases, you will need to form your LLC and then merge your S-corp into this new entity. If this is the option you have, know that this conversion can be rather complex. 

Filing Requirements in California

To convert a California S Corporation to an LLC, you must follow a state-specific process. In California, the standard approach is to file both of the following with the Secretary of State:

  • Certificate of Conversion (Form LLC-1A) – This form formally indicates the entity’s intent to convert from a corporation to an LLC.
  • Articles of Organization (Form LLC-1) – This form creates the new LLC entity.

These documents must be filed together, and the conversion is only effective upon filing (or a later effective date specified in the form). Additionally, California law requires that the S Corporation be in good standing—meaning all state taxes and filings must be current—before the conversion can proceed.

Converting S-Corp to LLC: General Procedures

If you are planning to convert your S-corporation to an LLC, you will require authorization from all shareholders. Since there may be tax-related ramifications, most states require a unanimous decision. Once you do agree, you can begin the conversion process. This will require you to either complete a merger or file a Certificate of Conversion.

You will then need to notify the IRS. Also, be mindful that S-corporation shareholders may need to pay tax on the liquidation of the corporation itself. This is what's known as capital gain tax. In comparison to C-corporations, the following is true of S-corporations:

  • They are only subject to one level of tax.
  • They should be careful when moving the S-corporation's stock to the LLC

Overall, this conversion can be fairly complicated, and proper due diligence is required. In some cases, seeking legal counsel is highly recommended. This is particularly true when liquidating a corporation.

Shareholder and Board Approval

Before you can convert a California S corporation to an LLC, the corporation’s board of directors must first approve the plan of conversion. Following board approval, shareholders must consent to the conversion as required by California Corporations Code Section 3300. In most cases, unanimous consent from all shareholders is needed to proceed, especially due to the tax implications of the conversion.

It’s advisable to create a formal plan of conversion that outlines:

  • The name and structure of the new LLC
  • The effective date of conversion
  • The manner of converting shares into LLC membership interests
  • Statements affirming the rights and obligations of the members

A properly documented plan ensures a smoother legal transition and helps prevent future disputes.

Various Elements of Conversion

Before you begin this process, know that there is more than one possible tax status for an LLC, more than one kind of corporation, and more than one type of conversion. 

  • There are C-Corporations, which pay corporate taxes. There are also S-corporations, which enjoy pass-through taxation.
  • Corporations are also formed under differing state laws.
  • LLCs can have one owner or "member," or they can also have multiple members.
  • Multi-member LLCs may be taxed as a partnership, as a "disregarded entity," or as a corporation.
  • When converting, you can do so via a statutory conversion, a non-statutory conversion, or a statutory merger. 

With various options, not all conversions are considered to be fundamentally equal. 

Statutory Conversion vs. Statutory Merger in California

In California, there are two main methods to convert an S corporation into an LLC:

  1. Statutory Conversion
    This is the simpler and more streamlined option when allowed. It involves filing a Certificate of Conversion and Articles of Organization in one step. This method does not require forming a new entity and merging—it simply changes the existing corporation into an LLC.
  2. Statutory Merger
    This option is used when statutory conversion is not available or suitable. It requires:
    • Forming a new LLC
    • Drafting a merger agreement
    • Having the S corporation merge into the newly formed LLC
    • Filing a Certificate of Merger and Articles of Organization

While more complex, the merger route may be necessary when legal or tax considerations make direct conversion impractical.

Converting S-Corp to LLC: Tax Consequences

Before you complete a conversion, understand that there may be tax consequences. Regardless of the method of conversion, the IRS will still view this process as an S-corp liquidation. Shareholders may also be subject to capital gain tax. If your conversion will not be a straightforward process, it's best to seek advice from your attorney before making any significant changes. 

California Franchise Tax and Final Returns

When converting a California S Corporation to an LLC, you must account for state tax obligations:

  • Final Tax Return: The S corporation must file a final California Form 100S, indicating it is the final return.
  • Franchise Tax: California requires that any final tax liabilities and minimum franchise taxes are paid before or during the conversion.
  • LLC Annual Franchise Tax: Once the conversion is complete, the new LLC must begin paying the $800 annual LLC tax, plus any gross receipts fee if applicable.

Note that the IRS treats the conversion as a liquidation of the S Corporation, which can trigger capital gains taxes for shareholders on the appreciated assets distributed to the LLC.

Converting S-Corp to LLC: Advantages

Once a conversion is complete, many of the corporate formalities associated with an S-corporation will be eliminated. As an LLC, you can enjoy greater flexibility in terms of management and greater taxation options. You will automatically be taxed as a partnership (for multi-member LLCs) or a sole proprietorship (single-member LLCs). However, you also have the option of S-corporation election. 

Within most states, LLC owners are also protected from what's known as "changing order" statutes. 

If you believe that converting from an S-corp to an LLC is the best move for your business, become familiar with your state's requirements. You should also familiarize yourself with the types of status conversions and what they mean in terms of taxation. 

Post-Conversion Steps and Compliance

Once the conversion is complete, several follow-up actions are required to ensure compliance:

  • Update EIN or Apply for a New One: The IRS may require a new Employer Identification Number for the new LLC.
  • Amend Business Licenses and Permits: Update the entity type on local, state, and federal business licenses and permits.
  • Revise Contracts and Agreements: Notify business partners, vendors, and clients of the entity change and update contracts accordingly.
  • Bank Accounts: You may need to close the corporation’s accounts and open new ones in the LLC’s name.
  • Notify Tax Agencies: Update your status with the California Department of Tax and Fee Administration (CDTFA) and Employment Development Department (EDD).

Keeping up with these compliance tasks ensures your newly converted LLC avoids penalties or delays in operation.

Frequently Asked Questions

1. Do I need shareholder approval to convert a California S corporation to an LLC? Yes. In California, converting an S Corp to an LLC typically requires approval from all shareholders.

2. What forms are required to convert in California? You must file a Certificate of Conversion (LLC-1A) and Articles of Organization (LLC-1) with the California Secretary of State.

3. Will I have to pay taxes on the conversion? Yes. The IRS generally treats the conversion as a liquidation, which may trigger capital gains taxes on appreciated assets.

4. Can I keep the same EIN after converting? In many cases, you’ll need to apply for a new EIN, but you should consult the IRS or a tax advisor to confirm based on your situation.

5. What happens to my business licenses and contracts? You must update all licenses, registrations, and contracts to reflect the new LLC structure after conversion.

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