Since creating alimited liability company(LLC) is an easy process in most states, many business owners opt for this structure when establishing their company. But sometimes, a company's goals outgrow the LLC structure, and the owners want to convert their LLC into a corporation.
Conversion requires more paperwork and has tax repercussions and additional filing requirements. Here is some guidance to help you evaluate whether conversion into a corporation is the best move for your LLC.
Why convert an LLC into a corporation?
You might want toconvert your LLC into a corporationfor practical reasons.
“If your company is exhibiting significant growth, converting from an LLC to a corporation will give you the flexibility to allocate some profits to qualify for a lower income-tax bracket," says Paul Sundin, a CPA and tax strategist forEmparion.
If you plan to offer stock options to employees, this benefit is available only through a corporation. In addition, “incorporating has a positive effect on a company's legal liability," Sundin says. “As an LLC, getting sued would mean risking your personal assets if you lose a case. A corporation, however, is only liable for the assets owned by the company."
Advantages of converting
According toDan Nguyen, a California business attorney, here are some additional benefits of converting an LLC into a corporation.
- In a corporation, shares of corporate stock are freely transferable by sale, gift, or pledge. In addition, the “transfer of stock does not affect the separate legal status of a corporation," Nguyen says.
- It is easier to raise capital and implement employee incentive plans, and corporations can deduct some health insurance and fringe benefits.
- The management structure is well-established in a corporation.
- In certain states, like California, some tax benefits are available to corporations that aren't available to LLCs.
Disadvantages of converting
One of the biggest disadvantages of conversion is that a “corporation is subject to double taxation—with both the company and its shareholders paying taxes on profits," Sundin says. However, if your business qualifies as anS corporation, profits pass through to shareholders' personal tax returns, and the corporation avoids double taxation.
Keep in mind that the cost of certain maintenance items increases in a corporate structure, such as the necessity of recording minutes of meetings as well as additional tax-filing requirements. The management structure in a corporation is less flexible. An LLC is simpler to operate.
What's the right decision?
It depends. As an LLC owner, you need to evaluate the company's profits, how fast it is growing, and whether the current structure provides the protections you need, such as greater liability protection and tax savings. Contact an accountant or attorney to determine the best course of action.
How do you convert an LLC into a corporation?
In general, three types of conversions are possible, depending on your state.
Statutory conversion
Many states already have statutes in place that make a quick-status conversion simple and straightforward. You fill out some forms with your company name, Employer Identification Number, address, and the registered agent's information and submit these to the secretary of state.
Statutory merger
Through this process, you merge your existing LLC into a new corporation. Here are the steps:
- Create a new corporation.
- Take a vote among the LLC members approving the change from members to stockholders.
- Change membership rights to agreed shares in the corporation.
- File a certificate of merger and other required documents with the secretary of state.
Nonstatutory conversion
Thisis the most expensive and difficult process of changing entities since it includes asset liquidation and dissolution of the existing company to create a new one. The new corporation absorbs all assets and liabilities.
Find out more about Forming Your Corporation
FAQs
“If your company is exhibiting significant growth, converting from an LLC to a corporation will give you the flexibility to allocate some profits to qualify for a lower income-tax bracket," says Paul Sundin, a CPA and tax strategist for Emparion.
What is the benefit of converting an LLC to an S Corp? ›
In one word, “Yes!” Converting your LLC to an S Corporation offers a host of advantages for your business. One of the primary benefits is the potential for significant tax savings, as S Corporations enjoy pass-through taxation — reducing your overall tax liability.
Is conversion of LLC to corporation taxable? ›
Changes in Taxation
The second tax consequence will result from your LLC conversion to a C Corp: As a C Corp, your company and your shareholders will experience taxation. Your new C Corp will be taxed on its annual profits first. After the company pays its dividends to shareholders, shareholders pay a second tax.
Is it better for an LLC to be taxed as a corporation? ›
If you're now wondering, “should my LLC be an S Corp”, the key to that answer is the amount of profit your business earns. As a general guideline, if you earn about $80,000 or more in profit through your business, S Corp status is probably beneficial. But that depends on how much you pay yourself as a salary.
Why would you form a corporation instead of an LLC? ›
It can be easier to obtain outside funding as some investors and banks prefer to invest in corporations than LLCs because corporations are generally better for recapitalizing and reorganizing over time as a business grows.
What happens when an LLC converts to a corporation? ›
In a statutory conversion, the LLC's assets and liabilities automatically transfer into a corporation. There's no need to form a new corporation and dissolve the LLC.
How much does it cost to convert an LLC to S-Corp? ›
So, technically, it costs nothing to change an LLC to an S-corp. However, you may need to pay some fees after filing Form 2553. For example, if you check the box Q1 to establish a “business purpose”, you'll need to pay a fee of $6,200.
What are the tax consequences for converting LLC to C Corp? ›
One significant tax consequence that arises when converting an LLC to a C Corporation is the loss of pass-through taxation. Pass-through taxation is a characteristic of an LLC where the company's profits and losses “pass-through” to the individual members' personal tax returns.
Do I need a new EIN if I convert from an LLC to a corporation? ›
Generally, businesses need a new EIN when their ownership or structure has changed. Although changing the name of your business does not require you to obtain a new EIN, you may wish to visit the Business Name Change page to find out what actions are required if you change the name of your business.
How long do I have to turn my LLC into an S corp? ›
To qualify for S corporation status in your first year of business, you need to file Form 2553 within 75 days of the date of the state conversion. The election will not be in place until the following year if this is not completed within that time frame.
An LLC owner might benefit from a less lofty Social Security and Medicare tax burden if electing S Corporation tax treatment for their single-member LLC. However, there are other factors to consider, such as the additional tax reporting requirements and possibly more scrutiny by the IRS.
Do corporations pay more taxes than LLC? ›
As a separate legal entity, corporations are responsible for paying taxes on the corporate level. The federal corporate income tax rate was 21% in 2022. LLCs do not pay this tax; rather, the company profits get passed to the owner and they pay personal income tax.
Can a single-member LLC be taxed as a corporation? ›
For income tax purposes, an LLC with only one member is treated as an entity disregarded as separate from its owner, unless it files Form 8832 and elects to be treated as a corporation. However, for purposes of employment tax and certain excise taxes, an LLC with only one member is still considered a separate entity.
What happens if you start an LLC and do nothing? ›
All corporations are required to file a corporate tax return, even if they do not have any income. If an LLC has elected to be treated as a corporation for tax purposes, it must file a federal income tax return even if the LLC did not engage in any business during the year.
Should I go LLC or corp? ›
In most cases, it is best to start off as an LLC or S-Corporation because these are most suited to minimize your taxes early on AND provide legal protection. Think about whether you plan to raise money. If you do, an S-Corporation is likely to be your best bet. If you don't, it's more beneficial to form an LLC.
Should I do LLC or corporation? ›
If your business is small and you want to be able to choose your business partners, you may appreciate these LLC restrictions. If, however, you plan to seek outside investors or provide company shares to employees, then you'll need a corporation's easy share transferability and eternal life.
How to convert LLC to S corp for taxes? ›
To elect for S-Corp treatment, file Form 2553. You can make this election at the same time you file your taxes by filing Form 1120S, attaching Form 2533 and submitting along with your personal tax return.
Can you convert LLC into C Corp? ›
Statutory Conversion
Create a plan of conversion from your LLC to a C Corp. This will lay out the details of the conversion, such as entity name before and after conversion and any terms and conditions. Your state may provide a template to be filled out. Have this plan approved by the members of your LLC.
How to convert LLC to corporation with IRS? ›
Thus, an LLC with multiple owners can either accept its default classification as a partnership, or file Form 8832 to elect to be classified as an association taxable as a corporation. The Form 8832 is also filed to change the LLC's entity classification.
Can a single member LLC be taxed as as Corp? ›
The default federal tax status for a single-member limited liability company (SMLLC) is disregarded entity. However, the owner of an SMLLC can elect to have the business taxed as either a traditional C corporation or as an S corporation. An S corporation is a special type of small, closely-held corporation.
