6 min read
Converting your LLC to a corporation can be a smart move for your business, but the specific steps may vary depending on the state where your LLC was formed. In this article, we'll discuss the advantages of converting to a corporation, the differences in taxation, and the process for converting.
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LLCs are the go-to choice for many small businesses because of their ease of setup, limited formalities, and favorable tax treatment. And learning how to create an LLC makes it easier to start small and scale efficiently. As an LLC owner, your personal assets are protected from business liabilities, and you have the option to choose how your business is taxed—either as a disregarded entity, partnership, or by electing S Corporation status.
However, as your company grows, an LLC might not offer the structure or flexibility needed to raise capital, attract investors, or accommodate future growth plans. That’s when converting your LLC to a corporation may become a more attractive option.
Before jumping into a conversion, it’s important to carefully consider whether moving from an LLC to a corporation is the right choice for your business. Here are a few key questions to ask yourself:
One of the biggest advantages of forming a corporation is the ability to issue shares of stock. If you’re planning to raise capital from venture capital firms or angel investors, you’ll likely need to be a corporation. Most investors prefer corporations because they can issue various classes of stock, protect shareholders from liabilities, and offer more structured governance.
LLCs can also bring in investors, but corporations tend to provide a more familiar and scalable framework for raising substantial capital.
For businesses experiencing rapid growth, converting to a corporation can be beneficial. Corporations offer a more formal structure that includes a board of directors, officers, and shareholders. While this added layer of formality comes with administrative requirements, it can also provide the governance and oversight needed for larger, more complex operations.
As a corporation, you’ll be better positioned to manage the challenges of scaling, attract professional leadership, and potentially prepare for an IPO (Initial Public Offering) if that’s part of your long-term strategy.
Corporations are taxed differently than LLCs. If your business is already highly profitable, you may benefit from the corporate tax structure, especially if you’re planning to reinvest profits back into the company rather than taking them out as distributions. Additionally, corporations can offer more tax planning strategies, including deductions for employee benefits like health insurance and retirement plans.
It’s important to weigh this against the potential downside of double taxation, where corporate profits are taxed at the company level and again when distributed to shareholders as dividends.
If your business is growing and expanding across multiple states, the legal formalities of a corporation might be more suited to your needs. Corporations are more easily recognized and understood by regulatory authorities in various states and internationally, which can simplify compliance and expansion efforts.
Corporations can issue stock options and other equity-based incentives to employees, which are powerful tools for attracting and retaining top talent. While LLCs can also issue profits interests, the process is often more complex and less familiar to potential employees. If you’re aiming to bring on high-level executives or employees who expect equity compensation, converting to a corporation can make your company more competitive.
Now that you’ve assessed whether it makes sense to convert your LLC, let’s look at some of the potential benefits of making this change.
As mentioned, corporations have more flexibility in raising capital. They can issue various classes of stock, which appeals to investors who may want preferred shares or other customized equity terms. This can give you greater access to growth capital, especially if you're looking to scale quickly.
Corporations are more easily structured for mergers, acquisitions, or even IPOs. If you’re planning to sell your business or go public in the future, converting to a corporation now can simplify that process. Buyers or investors typically prefer corporations due to the standardization of corporate governance and tax structures.
If attracting and retaining talented employees is a priority, converting to a corporation gives you the flexibility to offer stock options and equity compensation. This can help you attract top-tier talent, especially in competitive industries like tech or finance.
Being structured as a corporation can enhance your company’s credibility, particularly with larger clients, investors, and partners. Many larger organizations prefer to work with corporations because they have a more formal governance structure, which ensures a higher level of accountability.
While corporations are subject to double taxation, there are situations where being a corporation can actually result in tax advantages. For example, if you don’t plan to distribute all profits to shareholders and instead plan to reinvest in growth, you may be able to benefit from the lower corporate tax rate (compared to individual income tax rates). Additionally, corporations can deduct expenses like health insurance premiums and certain retirement contributions, which can provide significant tax savings.
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There are three ways to convert from an LLC to a corporation: statutory conversion, statutory merger, or non-statutory conversion. Statutory conversion is the easiest and least expensive method, but it may not be available in every state.
Before proceeding, check with your state to see if this option is available.
If statutory conversion is available, you will need to prepare your plan of conversion, which outlines the terms and conditions of your new direction as a corporation. It is important for your members to approve this plan.
You will also need to file necessary documents with the state's business filing agency under the Secretary of State office. Although different states have different rules and forms, the most common documents to file are Articles of Incorporation, which contain important data about your company, and corporate bylaws that set the tone of how you will run your new corporation.
You will also need to complete a certificate of conversion, which may be called different names in different states (such as articles of conversion or statement of conversion), but your filing office should provide you with the proper form.
Once you have all of the necessary documents, you can submit the certificate of conversion along with your Articles of Incorporation and bylaws (if required) to your state filing office. You will need to pay an incorporation fee of around $100 to $300 when you file your Articles of Incorporation and bylaws.
Once you’ve decided that converting your LLC to a corporation is the right move, the process is relatively straightforward. Here’s a step-by-step guide to help you through the transition:
You’ll need to decide whether to convert your LLC into a C Corporation or an S Corporation. A C Corp is taxed separately from its owners, while an S Corp is a pass-through entity for tax purposes. Each structure has its pros and cons, so consult with a tax professional to determine which is right for you.
You’ll need to file the appropriate conversion documents with your state’s Secretary of State office. Each state has its own procedures for converting an LLC to a corporation, so make sure to follow the specific requirements for your location. Some states may require you to dissolve your LLC and form a new corporation, while others allow for a more streamlined statutory conversion process.
Once your LLC is officially converted to a corporation, you’ll need to draft corporate bylaws, appoint a board of directors, and issue stock certificates to the company’s owners (formerly the LLC members). This formalizes the governance structure of your new corporation.
You’ll also need to inform the IRS of your new corporate status. If you’re electing to be taxed as an S Corporation, file Form 2553 with the IRS to make the election. You’ll also need to update your tax filings, payroll, and accounting systems to reflect the new structure. Also, assess if you need a DBA for your LLC during the transition to a corporation.
Make sure to update any contracts, licenses, and permits to reflect your new corporate entity. This might include agreements with clients, vendors, or partners, as well as banking and financial accounts. Don't forget to document changes using an LLC meeting minutes template to maintain compliance.
Converting your LLC to a corporation can be a wise decision for many businesses. It can help you raise capital, access tax benefits, issue shares to employees, and keep your company running indefinitely. If you decide to convert, make sure to research the specific steps required in your state and consult with a lawyer on tax planning.
Related: Creating an LLC: A Step-by-Step Guide
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