Learn about the benefits and drawbacks of changing from a C Corp to an LLC. It’s important to know your rights and responsibilities under both structures before making the switch.
Keeping up with the annual reports and filings to maintain a corporation can make changing from a C Corp to an LLC (limited liability company) a good choice. The LLC is a much easier entity to manage, and the tax benefits are superior to those you gain by owning a C Corp. Switching to an LLC does pose some challenges if you have outside investors who want a stake in the company, but there are legal solutions that make it possible to convert to an LLC and ensure that everyone maintains their agreed upon “share" in the company.
One of the main benefits of changing from a C Corp to an LLC is the tax benefit. The C Corp is known for the infamous “double tax," where the corporate income is taxed as well as the shares that are distributed to shareholders. The income to the LLC will only be taxed once, and that’s when there’s a payout to the members of the LLC. The income passes through to the members tax free.
Another benefit of changing from a C Corp to an LLC that can’t be minimized is that you as a member have more control in the management of the LLC. A C Corp requires a board of directors, and although you may be one of its directors, you don’t have as much control as an LLC member. An LLC functions more like a partnership, and you can take a more hands-on approach than with a C corp.
Disadvantages to Switching
There are disadvantages that you need to be aware of before you make the switch. To begin with, members of the LLC wouldn’t be able to freely sell their interests in an LLC. What they can sell depends on the LLC operating agreement. When you own shares in a C Corp, you have more flexibility to sell shares. You also have to consider the state where you’re forming the LLC, because each state has its own laws and requirements that may make it more difficult to keep an LLC in good standing than a C Corp.
How to Make the Switch
The mechanics of changing are fairly straightforward in many states. You have to file a conversion with the state, as well as send a written notice to the IRS for tax purposes. For example, it’s popular to incorporate in Delaware even if you don’t operate your business there. Delaware makes it easy for business entities to switch from one type of business to another by filing a form titled, “Certificate of Conversion from a Delaware or Non-Delaware Corporation to a Delaware Limited Liability Company" with the Corporations Division. A “Limited Liability Company Certificate of Formation" needs to be filed at the same time to form the LLC.
In states where a conversion is not possible, or it’s difficult, you’ll have to dissolve the C Corp first, liquidate and/or transfer the assets to a new LLC that you create from scratch. This method of changing from a C Corp to an LLC is difficult to do if there are existing liabilities and contracts. The C Corp has to terminate those agreements first, and pay off liabilities before they can effectively dissolve the C Corp and make the switch.
Check your state laws to see whether a conversion is possible. That’s your best option when moving from a C Corp to an LLC. The fees tend to be hefty, often a couple of hundred dollars, but it’s better than the time and money spent on dissolving the C Corp, and then paying for form a new LLC.
Image Credit:Matthew Bowden