LLCs and corporations have significant advantages and disadvantages; when you’re starting your new business, one may seem better than the other, but as your business grows, you realize that the other business entity would better suit you. In that case, entrepreneurs may need to complete a reorganization.
If you need to convert your corporation to an LLC, or your LLC to a corporation, there are two core ways to do this. You can complete a statutory conversion or statutory merger. The difference between these two methods will be explored below.
LLCs vs Corporations
As businesses grow and develop, business needs can change, meaning you need to convert your business. What works for a small business may not work for a larger business, often requiring you to form a new corporation or type of entity.
Undertaking a conversion can be a lot of hassle, regardless of the method you choose. You could avoid needing to convert if you pick the correct business entity in the first place, but it’s not always so clear-cut. Still, LLCs and Corporations have several clear advantages.
There are some advantages that operating an LLC brings, including:
- No limit on members (or owners)
- Limited personal liability/personal asset protection
- Pass-through IRS taxation
- Flexible management
- Distribution of profits determined by owners
- No annual meeting rules
- Fewer formalities than a corporation
LLC owners enjoy limited liability protection; limited liability protection means that you can avoid being held personally liable for business debts.
There are no maximum limits to the number of people (or businesses) that can own an LLC; however, S-corporations have a maximum of 100 shareholders.
Similar to S-corporations and sole proprietorships, LLCs operate as a pass-through entity with the IRS. All profits and losses are declared on the owners’ personal tax returns.
LLCs also enjoy flexibility in the management structure; the owners can choose to manage a business alone (member-managed LLC) or hire a third party to manage their LLC (manager-managed LLC). Members can also give themselves jobs and job titles like a corporation if they choose. Each owner owns a portion of the LLC, but profits can be distributed in any way agreed upon; someone who owns a 52 percent share may only receive 30 percent of the profits. Further to this, members can equally distribute profits even if the membership interest isn’t equal.
LLCs don’t have strict regulations like corporations do. There are no annual meeting requirements. LLC owners also have fewer restrictions than someone sitting on a corporate board of directors.
Advantages of a Corporation
There are many advantages to an LLC, but there are also key advantages to corporations.
Key advantages include:
- It’s easier to attract investors and increase capital
- Income splitting
- Savings on self-employment taxes
- Easier transfer of ownership
Corporate income splitting can help lower tax liability. Since corporations can sell stock to the public, they can increase capital faster. Owners can also hold various stock interests, preferred and common stock, allowing for various levels of dividends.
S-corps operate similarly to an LLC; the IRS will pass-through taxes, avoiding double taxation.
But C-corporations, also known as traditional corporations, do incur double taxes. C-corps must pay corporate income tax, and then shareholders pay tax on dividends and income reported on their personal tax returns.
S-corps provide savings on self-employment, medicare, and social security taxes by permitting shareholders to offset non-business income with losses from the business. However, C-corps don’t have that benefit.
S-corp shareholders can reduce their tax liability by claiming a ‘reasonable compensation’ if they are also employees, but overall corporations have negative tax consequences.
Transferring stock can transfer ownership. S and C-corps can freely transfer stock among shareholders. Transferring membership interest in an LLC has more complications.
The statutory conversion is the easiest way to convert your business entity from one to the other, conversions were introduced into the American business market quite recently, and they’re not available in all states; they’re only available in around 35 jurisdictions. The process varies state by state but usually agrees with an organization’s ownership group agreeing to the conversion and drafting a plan of conversion, which outlines how the conversion will take place and the anticipated result.
The process also varies depending on the organization type. With an LLC, you need most of the LLC members (assuming it’s not a single-member LLC) to approve the plan. In a corporation, your stockholders will need to approve the plan. The next step is typically a certificate of conversion; the precise information required to complete the certificate varies on a state-by-state basis, but usually, you’ll need to provide the Secretary of State’s office with the following:
- Your business name
- Your current business type
- Your business location
- Your business mailing address
- Your registered agent’s name and address
- The business entity type you’re converting to
- The results of the company’s voting process
- The company’s authorized person’s signature
You’ll typically need to file the articles of incorporation (for a corporation) or the articles of organization (for a limited liability company). You may also need an operating agreement. You’ll also need to prepare and file the business formation documents for your new business entity – similar to a startup. Business formation services can complete this step for you.
Then you need to formally dissolve your original entity, completing your statutory conversion.
The other common way to convert a business is the statutory merger; the merger begins with the brand-new formation of a business entity and the liquidation of the disregarded entity. You’ll need to form a new organization (like any other startup) before completing a plan of merger and holding a vote to approve the merger. The merger will combine your new entity and your existing entity. The new entity will be the surviving entity.
After that, your business owners/members will need to formally (voluntarily) trade in their ownership for ownership shares in the new entity. Once this is complete, you’ll need to draft and file your certificate of merger.
The certificate of merger is filed with the Secretary of State and officially merges the two companies. This is less preferable because there’s more hassle and potential stumbling blocks involved. Statutory mergers tend to be more expensive. But, statutory conversions aren’t available in all states, so this may be your only option.
Hiring a professional
If this process sounds like too much hassle, you can hire professionals to take care of it. Business attorneys will undertake these jobs, but it could get expensive fast. Thousands of dollars is a likely estimate. But some business services companies may complete the task for you for less. There aren’t as many options for this as simple company formation, but they do exist. Swyft Filings, Legal Zoom, and several other providers offer competitive conversion services.
Generally, statutory conversion is simpler than the merger for converting a business from one entity type to another. However, they aren’t available in all states and each type of merger has drawbacks and differences depending on the laws of the jurisdiction. Some business owners will be forced to complete a merger regardless. If either process is too much hassle, you can hire professionals to take care of it for you. BizFilings, LegalZoom, and Swyft Filings are competitive providers that can complete your conversion process.