Partnership To LLC: Everything You Need to Know
Converting a partnership to LLC is relatively straightforward.3 min read
2. Steps to Change a Partnership to an LLC
3. Conversion Tax Issues
4. Conversion Liability Issues
Converting a Partnership to LLC
Converting a partnership to LLC is relatively straightforward.
Generally, each partner must sign the company’s operating agreement and then file articles of organization with the state agency responsible for registering business organizations. However, each state is different, and some states may instead require a certification of formation.
There are several reasons why business owners want to convert to LLCs, but the main reasons are for tax and liability reasons. For example, LLC owners can elect to be taxed as a partnership. Partnerships have what is called “pass-through” federal taxation, which means the business’s taxes are “passed through” to the business owner’s individual tax return.
Moreover, for liability purposes, general partnership owners have joint and several liability, which means that the partners can be collectively and individually personally liable for the partnership’s debts and obligations. LLC owners, however, are protected from personal liability and are only liable up to their individual investment in the LLC.
Steps to Change a Partnership to an LLC
First, each state has its own LLC-formation regulations, so read your state’s regulations.
Download, complete, and file the articles of organization.
Completing the Form
Many states allow you to convert your partnership into an LLC in one step by filing a form (e.g., see California’s LLC 1-A form). Regardless if your state allows a one-step conversion form, there are certain items in the articles of organization you need to complete.
You will need to provide your LLC’s name and address. You do not have to keep your partnership’s old name. You can choose a new identity. However, in both cases, you can do so by adding “Limited Liability Company” or “LLC” to the end of the name.
You will also provide the LLC’s registered agent, who is a person or business designated to receive service of process if the LLC is sued or subpoenaed. You may also have to designate who controls the LLC’s daily operations.
Filing the Form
If your state does not allow you to file a one-step conversion form, you must file the articles of organization form or similar document with your designated state agency for registering business organizations.
Each state has different filing and fee requirements, but generally you can file by mail or online and can expect a filing fee from $50-$350.
- Transfer the partnership's business assets to the LLC – Draft a bill of sale and list all the partnership’s assets and their values. Indicate that the assets are being transferred to the LLC.
- Cancel the partnership – If your general or limited partnership is registered with your state, you must download, complete, and file a Certificate of Cancellation with your designated state agency. You will need to include your partnership’s name and the reason for its dissolution.
- Obtaining New Bank Accounts and Tax IDs – Check with your bank to see if you need a new bank account. You will need a new tax ID if your business or ownership changes.
Conversion Tax Issues
A conversion from a partnership to an LLC is a nontaxable event. Generally, you contribute the partnership’s assets to the LLC in exchange for membership shares. Consequently, you can continue to be taxed as a partnership and can also qualify for a tax emption for any business property appreciation. However, if ownership percentages or business debt is changed during the conversion, there may be tax consequences.
For example, a business loan that an owner personally guarantees is considered recourse debt, which the owner can use as a deduction against his partnership income. Moreover, if the partner changes the debt he or she personally guarantees, it will likely be considered the partner’s income, which may be treated as a cash distribution from the LLC. The LLC member may be taxed as if he or she were paid in cash.
Conversion Liability Issues
Just because an LLC has assumed a partner’s business debts, it does not mean that a partnership’s creditors will automatically release a general partner from personal liability.
LLC members are not held personally liable for debts the LLC incurs but will remain personally liable for debts the partnership transferred to the LLC.
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