While a limited liability company (LLC) has its own set of advantages, there may come a time that, due to the disadvantages of this business entity, owners may decide that they want to convert from an LLC to a C corporation. Yet, while this process may seem daunting and stressful, it does not need to be.
The below guide will walk you through everything you need to know when preparing to convert LLC to C corp, including the benefits and disadvantages of this conversion and the exact steps you need to take.
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Why Would You Want to Convert an LLC to C corp?
One benefit of converting an LLC to a C corporation is that it allows owners to create equity in their new corporation, which helps to offer equity to employees and attracts investors. This is key because owners need to find ways to attract these investors if they want to raise money for their businesses. And usually, investors, such as venture funds, cannot invest in pass-through companies because they have tax-exempt partners who do not want to receive business or active trade income due to their status.
As a result, investing in an LLC may be a risky choice for investors. That is why when companies switch to a C corporation, more investors are willing to put their money into the business because it’s less of a risk.
What Are the Benefits of a C Corp Over an LLC?
A C corporation refers to a legal entity that protects the business owner's personal assets from creditors. It can also have multiple classes of stock and an unlimited amount of owners. These corporations also limit the liability to investors, meaning that the most an investor can lose if a company fails is the amount they had invested.
Additionally, some other considerable advantages of having a C-corp include:
- The C-corp has a separate legal identity, allowing it to sue or be sued in its own name. This also means that this structure provides owners limited liability protection.
- The C-corp has no restrictions on who can hold shares.
- The C-corp continues to exist until it is dissolved, liquidated, or wound up unless the Articles of Incorporation say otherwise. Consequently, even if the company owner dies, the business will continue.
- The C corporation has readily transferable shares.
- The C corporation has well-established legal precedents meaning that management and investors can better gauge what the legal consequences may be based on a company's decision.
- The C corporation offers a comprehensive arrangement of tax planning opportunities.
What Are the Disadvantages?
Although there are countless benefits when converting an LLC to a C-corp, this arrangement also has some disadvantages. Three of the most significant downsides to a C corporation include the following:
- A C-corp is more complicated to manage and operate than an LLC. The laws surrounding a corporation also have more formalities that must be met to ensure the company is adequately handled.
- A C corporation is a separate tax-paying entity unless it makes an election to be taxed as an S corporation. However, if it doesn't, the C corporation will pay corporate income tax. Then it will pay shareholders dividends from its after-tax income. These shareholders will then have to pay personal income taxes on these dividends. As a result, the situation results in "double taxation."
- A C corporation involves higher costs meaning that starting and maintaining one is costlier than other entities.
What Do You Need to Prepare in Advance?
Before committing to this change and converting your LLC to a C corp, it is important to prepare in advance. This means you will want to evaluate the company's goals, profits, taxes, management style, and whether your current structure offers you everything you need, such as certain protections. If you are having a hard time making this decision, it may be a good idea to talk to professionals such as financial experts or a lawyer to figure out which course of action you should take.
For instance, from a tax perspective, you need to consider how an LLC is taxed. Usually, you will get taxed as a disregarded entity. You will also get taxed as a partnership if you are one of the multiple owners.
However, regardless of how you will get taxed, the IRS will consider you self-employed in both situations, which means you will have to pay Medicare and Social Security taxes based on your company's net earnings. In comparison, if you are a C corp, you will be subject to double taxation, which may mean you will still end up paying more in taxes than you would if you had an LLC.
That is why it is crucial to consider all these issues before making this transition to ensure it is the right move for you and your company.
Steps to Converting From an LLC to a C Corp
If you decide that you want to convert your LLC to a C-corp, there are a few steps you will need to take to complete this change. However, while these steps will typically depend on your location, the basic process for converting will generally include the following.
Step One: Get Approval From the Members
The first thing you will want to do before converting your LLC to a C corp is to get member approval or meet the basic voting requirements as outlined in the LLC's Articles of Organization. The Article of Organizations is a document that legally establishes the existence of your LLC and sets forth details about your company and the things you can do with it.
Step Two: Figure Out How You Want to Convert Your LLC into a Corporation
There are two main ways to convert your LLC into a C-corp. However, your method will depend on the state laws where your LLC is registered. These options include the following:
- Statutory Conversions: This streamlined process converts the LLC into a corporation by turning the members of the LLC into stockholders and transferring the LLC's liability and assets to the corporation without having to dissolve the business. Yet, while this method may be cheaper and more manageable, it is not available in every state.
- Statutory Merger: This second option is more complicated than a statutory conversion, but it is often a great option if your state does not allow for statutory conversions. Under a statutory merger, a new entity is established before the prior LLC is absorbed. This method converts the LLC members' interests to stock in the new entity, and then the LLC is formally dissolved.
There is also a third option, but hardly anyone goes this route. The non-statutory conversion option removes all of the LLC members’ interests, liabilities, and assets and then formally designates them to the new entity. However, this method requires all the members to agree to the proposed structure officially and often results in a complicated undertaking requiring an attorney's help to ensure everything is completed correctly.
Step Three: File the Forms With the Secretary of State's Office
No matter which option you choose, you will need to make sure that you complete this transaction correctly, and once everything is complete, you file the proper forms and documents with the Secretary of State's office.
Step Four: After You Convert, Make Things Official
After converting your LLC to a C corporation, you will need to take action to make everything official. This includes:
- Creating your corporate bylaws
- Updating bank records
- Electing directors and board members
- Issuing stock certificates
- Updating marketing materials, websites, and other services such as your bookkeeping, accounting, financial reporting, annual budgeting, taxes, HR, and payroll services
- Getting the appropriate permits and licenses
- Holding your first shareholder and board member meetings
The Bottom Line on Converting
Converting your company from an LLC to a C corp might be the right call for your business. However, before making this transition, you must confirm that this conversion is best for your goals, priorities, and future needs. You also want to ensure you are prepared to make this change by having the right help.
If you are considering converting your business from an LLC to a C corporation, check out Hiline today. Our team of experts can provide you with advice and insight to make sure the decisions you make regarding this conversation are appropriate. We can also ensure your business thrives in the long run by providing you with a one-stop shop of cloud-based accounting, tax, and financial services.
For more insight into how our services can help you with this conversion, check out our services today for further details.
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