Electing to convert a business from an LLC to a corporation is subject to the laws of the state where the limited liability company was organized. Some states have enacted a conversion statute that streamlines the process for conversion; other states maintain the traditional procedures for conversion, which requires multiple steps to complete the process.
Conversion Statute Process
In states that elect to expedite the conversion process, converting an LLC into a corporation requires the filing of a prescribed standard form. The conversion form is available through the Secretary of State's office, or similar regulatory agency, and typically may be filed in person, by mail or online. The form sets forth the intent of the LLC to convert its organizational structure to that of a corporation. The form typically includes an affirmation to comply with all laws applicable to corporations organized in the state.
Traditional Conversion Process
The traditional conversion process represents a more cumbersome, multi-step procedure. Under the traditional conversion process, owners of an LLC, known as members, must vote to convert the entity. A separate corporation is then formed by filing articles of incorporation with the Secretary of State. The assets and debts of the LLC are conveyed to the new corporation and a certificate of dissolution for the LLC is filed with the Secretary of State.
Immediate Tax Consequences
The immediate tax consequences center on how the Internal Revenue Service addresses the conversion. The IRS utilizes one of three categories when dealing with the conversion of an LLC to a corporation. An assets-over conversion exists when the LLC transfers its assets and liabilities to the corporation in exchange for corporate stock conveyed to the LLC. The LLC then transfers the stock to its individual owners. An assets-up scheme involves the transfer of the LLC's assets and liabilities to its owners who then convey the property and debt to the newly formed corporation. An interests-over conversion involves individual owners of the LLC transferring their respective ownership interest in the LLC to the corporation in exchange for a proportional share of the new corporation's stock.
Long-Term Tax Consequences
The long-term tax consequences associated with a conversion arise from the fact that the IRS applies what is called "pass through" tax liability on the LLC form of business. Here, the profits of an LLC are taxed once, at the level of the individual owners. Conversely, with a corporation structure, profits are taxed at the corporate level and any distribution or dividends paid to individual shareholders also face taxation by the IRS; this tax treatment is commonly referred to as double taxation.