How to Incorporate an LLC: Everything You Need to Know
To incorporate, LLCs need to make a number of changes including changing the name, changing the EIN, and appointing a board of directors.3 min read
2. Limitations of LLCs
3. Disadvantages of Corporations Compared to LLCs
4. How to Convert an LLC to a Corporation
5. Statutory Conversion
6. Statutory Merger
7. Changes That the Newly Converted LLC Must Go Through
How to incorporate an LLC? Converting an LLC to a corporation can be done through statutory conversion or statutory merger. Incorporating can make it easier for a business to get funding from investors. To incorporate, LLCs need to make a number of changes including changing the name, changing the EIN, and appointing a board of directors.
LLCs Versus Corporations
The LLC business type is one of the preferred entity types for smaller businesses. LLCs have pass-through tax status and normally have simpler structures compared to corporations.
On the other hand, corporations are suitable for businesses that intend to grow by attracting investors. A business that starts out as an LLC might find itself limited by some restrictions on LLCs.
Limitations of LLCs
Compared to corporations, LLCs have a number of limitations that might move some business owners to incorporate.
Transfer of ownership
The sale of LLC membership interest is restricted. Many states require any transfers to be approved by all LLC members unless the operating agreement of the LLC states otherwise. This requirement and other LLC restrictions can limit the ability of LLCs to attract investors.
Getting bank funding
Compared to corporations, LLCs are likely to have a harder time getting loans from lending institutions. It is common for lenders to insist that loans to LLCs be personally guaranteed by wealthy LLC members. This makes the LLC an undesirable business type for some business owners.
Disadvantages of Corporations Compared to LLCs
Before converting your LLC to a corporation, you should understand certain disadvantages your business will inevitably experience when it becomes a corporation.
Unlike LLCs which are pass-through entities for federal tax purposes, traditional corporations are required to pay federal corporate tax every year. This would likely eat into the earnings of shareholders.
Corporations have a number of mandatory structural and management requirements. They must appoint a board of directors, hold board meetings and shareholders' meetings, and record major corporate resolutions during the meetings. These formalities certainly mean that the business will have more expenses when it incorporates.
How to Convert an LLC to a Corporation
There is a provision for LLCs to be taxed as corporations. If an LLC makes use of this option, it does not need to go through the complex process of conversion. All that is needed is to file IRS Form 8832 to get C corp tax status or IRS Form 2553 to get S Corp status.
However, to fully benefit from the investor-attracting prowess of corporations, an LLC might need to incorporate. Conversion of an LLC to a corporation can be achieved by one of the two common methods: statutory conversion or statutory merger.
Statutory conversion is the easiest method of converting an LLC to a corporation. The exact process differs from state to state but it typically involves the following steps:
Electing to convert
The LLC's members must discuss and approve a plan for conversion. Depending on the LLC's operating agreement, this plan might need unanimous support of the members.
Filing the certificate of conversion
The LLC must then file a certificate of conversion to the state. This is normally accompanied by other paperwork including the original Articles of Organization of the LLC.
The membership interest of LLC shareholders is now converted to stock. After the conversion is approved, the LLC is dissolved.
Statutory merger is a more complex conversion method but it is normally the only option in states whose laws do not allow for statutory conversion. It typically involves the following steps.
Formation of a new corporation
The LLC must form a new corporation. This would involve filing a Certificate of Incorporation to the Secretary of State.
Merging the new corporation and the LLC
The new corporation is then merged with the LLC and the membership interest of the LLC members is converted into shares.
In rare circumstances, LLCs may be required to use another method of conversion called non-statutory conversion. This is complicated and needs the guidance of experienced tax lawyers.
Changes That the Newly Converted LLC Must Go Through
The new LLC has to get used to a number of changes including the following:
- It must file the Certificate of Incorporation to the state.
- It must appoint a board of directors.
- It must adopt corporate bylaws.
- It must hold annual board of directors and shareholders' meetings and keep a record of the meeting minutes.
- It must issue stock certificates.
- It must start paying corporate tax.
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