Changing from a C Corporation to an LLC avoids double taxation and gives owners more control. Follow this comprehensive guide for a look at the process.
Your business will go through many changes as it grows. However, as you expand into new markets and attract new customers, you may discover that the structure you started with doesn’t suit your needs anymore.
Fortunately, it’s possible to convert a C Corp to an LLC. This guide highlights the difference between a corporation and an LLC, why you may want to convert, and the benefits conversion can bring.
Key Takeaways
C Corporation owners deal with double taxation and strict management structures, while an LLC provides pass-through taxation and enhanced flexibility.
A statutory conversion is the simplest method to convert a C Corp to an LLC, but it is limited to certain states.
Statutory mergers and non-statutory conversions are additional options for a C Corp conversion.
Why Change a C Corp to LLC?
Changing a C Corp to an LLC structure can be complicated. Depending on the state where you formed the corporation using a C Corp formation service, you may have the option of a simple conversion without dissolving the original corporation. However, not all states offer this, making the process more complex.
But why would business owners decide to shift the C Corporation to a limited liability company? Here are some possible reasons:
- Avoiding the double taxation of C Corporations, as LLCs can undergo pass-through taxation
- Accessing a less formal hierarchy that doesn’t require a board of directors
- Gaining more control over business decisions
- Having profits that aren’t tied to shares
- Limiting the liability investors or members incur
The most crucial difference between the corporation and LLC structures is the tax implications. Accessing pass-through taxation could be a significant motivation to convert a C Corp into an LLC.
Let’s take a deeper look at some of these differences.
C Corp vs. LLC
Understanding the primary differences between a C Corp and an LLC helps you make an informed choice about conversion.
Feature | C Corp | LLC |
Taxation | Double taxation | Pass-through taxation |
Ownership | Unlimited shareholders | Member- or Manager-managed |
Management Structure | Formal, rigid management structure | Flexible management structure |
One attractive variance is the differing management structure of LLCs. LLCs don’t require a board of directors, adhere to one specific hierarchy, or utilize traditional job titles. For example, in an LLC, there’s no need to have CEOs and VPs if owners don’t want to.
Taxation is another strong motivator. In the eyes of the IRS, LLC companies are intrinsically linked to the owners rather than entirely separate entities. Owners are called members and can opt for the IRS to tax the entity as a partnership, corporation, or a disregarded entity on the owner’s individual income tax return.[1]
If a limited liability company offers so many benefits, why don’t all C Corporation owners opt to convert to LLCs? There are numerous reasons why:
- Expensive conversion costs, depending on the state
- Increased tax bills, as there’s no guarantee that pass-through taxation will be cheaper
- Complicated transfer of membership
- Generally less attractive to venture capitalists or angel investors as an LLC
- Potentially fewer ways to reward employees with the lack of shares
Business owners should always seek advice from business filing specialists with experience in the state where their business was first incorporated. This will determine conversion methods, costs, and regulations around where to file relevant documents.
How to Convert a C Corp to LLC
If you’ve decided that the benefits of an LLC are right for your business, you need to know how to change a C Corp to an LLC structure.
There are three main methods for approaching LLC conversion. However, not all methods are available in every state, so check with your accountancy professionals to understand the options available better.
1. Statutory Conversion
A statutory conversion from a C Corp to an LLC structure is limited to selected states. It’s the simplest method and requires:
- A vote from the board of directors to convert
- A plan of conversion approved by the board of directors and shareholders
- Your completed articles of incorporation
- A certificate of conversion
- A payment method for the state filing fees
If this process is approved, your new LLC can retain the same name and EIN as the C Corporation.
2. Statutory Merger
An entity merger is another way to convert C Corps to LLCs. The first two points in the process above remain the same — owners must gain the approval of the board of directors and shareholders prior to proceeding with this process.
The statutory merger process is as follows:
- Form a new LLC
- Gain a formal vote from shareholders to exchange shares for LLC membership
- File a certificate of merger with the secretary of state’s office
- File the appropriate documentation to dissolve the original C Corp
After a statutory merger, you’ll require a new Employer Identification Number (EIN). The cost of completing a statutory merger depends on the LLC incorporation fees in your state.
The timeline can also vary depending on how long it takes to contact all shareholders and the backlog of requests in your state.
3. Non-Statutory Conversion
A non-statutory conversion, or a non-statutory merger, is complex, costly, and potentially time-consuming. Onboarding an expert is essential for positive outcomes when utilizing this process.
Rather than merging two entities, this method involves the creation of an LLC and the dissolution of the C Corp as two distinct processes. The steps involved are as follows:
- Form a new LLC.
- Make a formal application to transfer the C Corp’s assets to the LLC
- Create a separate contract to transfer corporation shareholders to LLC members, with their approval
- Formally file for liquidation of the C Corporation with the secretary of state’s office
New LLCs incorporated in this way always require a new EIN.
C Corp to LLC: Final Steps
Congratulations, your established business or blossoming startup is now an LLC. Here are the final steps to check:
- Obtain a new EIN if you followed the merger or non-statutory process
- File Articles of Organization that establish the firm as a distinct legal entity
- Create an operating agreement that specifies members’ roles and responsibilities
- Open a business bank account solely for the new LLC for paying employees, taxes, etc.
Ensure all members are happy with the new management structure and be open to discussion and feedback at this early stage. Members should understand any changing tax implications before the conversion process reaches this stage. However, be transparent in communications to secure the trust of all members.
FAQs
Can I convert my C Corp to an LLC?
Yes, although state laws will determine how you approach this.
What are the benefits of converting a C Corp to an LLC?
The top reasons to convert C Corp to LLC entities include pass-through taxation, flexibility, and less formal management structures.
Can I convert my C Corp to an LLC in California?
Yes, California allows corporations to convert to LLCs. You must file the conversion forms with the California Secretary of State, and a $150 fee will apply as of January 2024.[2]
What if my C Corp is not profitable?
If the C Corp’s profits are low, switching to an LLC could cause owners to incur additional taxes. Speak to a tax expert to understand the implications.
What is the difference between a C Corp and an LLC?
The primary differences between C Corp and LLC firms are that LLCs incur pass-through taxation rather than double taxation, and enjoy a more flexible operating structure.
Do investors prefer a C Corp over an LLC?
Investors are more attracted to C Corp businesses because shareholders are only taxed on the dividends, not company profit.
Do I need a new EIN if I convert from a C Corp to an LLC?
It depends on which method you use. When you use the merger or non-statutory conversion process, you must always obtain a fresh EIN for the new LLC.
Bibliography
- IRS.gov. “Limited Liability Company (LLC).” Accessed January 16, 2024.
- California Secretary of State. “Conversion Information.” Accessed January 16, 2024.