There are several reasons to consider turning your LLC into a corporation, ranging from simplifying stock compensation to cutting taxes. You must also decide whether to incorporate as a S corporation or a C company.
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Reasons to Change Your LLC to a Corporation
While a limited liability corporation (LLC) form may be appropriate for your firm at first, it may not be appropriate in the long run. After a period, you may discover that operating as an LLC is impeding your company’s development for one reason or another. This is not unusual, and if you find yourself in this circumstance, you may convert your company from an LLC to a corporation. However, before making this move, you need evaluate some crucial variables and possibilities. Continue reading for additional information to help you determine if transitioning from an LLC to a corporation is the best next step for your business.
Reasons to Change Your LLC to a Corporation
For a number of reasons, business owners may contemplate changing from an LLC to a corporation. Here are a few examples of the most common:
You intend to raise funds from investors. Typically, investors choose to invest in firms. Why? Because companies have defined and transferable ownership shares, it is simpler to purchase and sell holdings in them. Corporations may also issue a different class of shares known as “preferred stock,” which investors often find appealing.
You intend to do a public offering. If you want to execute a public offering of common stock in the future, you must first establish a company.
You wish to compensate by issuing shares. It is significantly simpler to issue stock as compensation to original investors or organisers, or to periodically distribute it to staff as part of their regular salary, as a corporation rather than an LLC.
You want to be a part of a startup accelerator. Startup accelerators or incubators sometimes need incorporation since they accept equity.
You’d want to reduce your self-employment taxes. Members of an LLC must pay Social Security and Medicare taxes on their portion of the company’s earnings. In a company, owners are paid like other workers and must only pay taxes on the amount of their remuneration. Importantly, an LLC may elect to be taxed as a corporation without converting.
When Is It Time to Make a Change?
It might be difficult to determine the best moment to convert your LLC into a corporation, but a few broad criteria can assist. For example, if you want to do a stock offering in the future, you must make the change. Another element to consider is the point at which the amount of self-employment tax paid by the owners surpasses the amount of corporate tax paid by your firm as a corporation. Once you pass that point, you have one less incentive to maintain an LLC structure. However, keep in mind that LLCs may elect to be taxed as corporations without leaving the LLC form.
Corporations (S) vs. Corporations (C)
Another thing to keep in mind is that S companies and C corporations provide two separate company forms. While they have many similarities, they also vary significantly.
Similarities
Limited Liability Protection: S companies and C corporations, like LLCs, provide company owners with personal liability protection.
Both require business owners to submit formation paperwork with the state where the firm is based.
Both have shareholders, executives, and directors, and the corporation may distribute a portion of its income to shareholders as dividends depending on the number of shares held.
Both must convene shareholder and director meetings, record minutes of such meetings, issue stock, draught bylaws, and publish annual reports.
Differences
The most major distinction between S companies and C corporations is in taxation. C companies must pay taxes as independent entities with their own corporate tax returns at the federal level, while their shareholders must pay taxes on any dividends received from the company’s stock. S companies, on the other hand, are subject to “pass-through” taxes. That is, a S corporation does not pay income taxes and its shareholders pay taxes on their percentage of the company’s earnings. This may often result in a substantially smaller tax bill for S company owners. Furthermore, state taxes vary greatly, and S companies are not treated the same way everywhere.
Ownership Restrictions: S companies have more stringent ownership rules. They may, for example, have a limit of 100 shareholders and cannot be owned by non-U.S. citizens, C corporations, other S companies, LLCs, partnerships, or certain other organisations. Furthermore, S firms may only issue one kind of stock, while C corporations can issue numerous types of ordinary and preferred stock. S company ownership limits may make it more difficult to raise new cash or sell the firm.
Qualifications Required to Convert an LLC to a Corporation
The key requirements for converting your LLC into a corporation are related to ownership limits. Given the constraints on S company ownership, you must fulfil the following requirements if you select this structure:
Be a local business.
Have a maximum of 100 stockholders.
Have just one kind of stock.
Non-U.S. people, companies, or some other organisations may not be owners.
Three Methods for Converting Your LLC to a Corporation
If you wish to convert your LLC into a corporation, there are numerous options available based on your state. They are as follows:
Conversion by Statute
Statutory conversion is the newest option and is not accessible in all states. It is likely the easiest and least costly way. While the procedure varies significantly across the jurisdictions that allow statutory conversion, it typically entails developing and approving a conversion plan as well as completing applicable paperwork with the appropriate state regulatory agency. The automatic transfer of all business assets and liabilities from your LLC to the new corporation, as well as the status conversion of LLC members to corporate shareholders, is a key feature of a statutory conversion. That means you can avoid the extra steps and paperwork necessary by the other two ways.
Statutory Consolidation
A statutory merger requires the formation of a new entity first. The LLC members (who are now shareholders in the new company) must then approve the merger of the two entities and relinquish their LLC membership rights. The firms must next submit a merger certificate and associated papers with the relevant state regulatory body. Finally, you must dissolve the LLC. While this approach, like statutory conversion, immediately transfers assets and liabilities, it is substantially more difficult and time-consuming due to the additional formalities needed with initially forming a new organisation. However, in jurisdictions where statutory conversions are not available, it may be the best alternative.
Non-mandatory Conversion
This is the most complicated and, in general, the most costly method for converting an LLC into a corporation since it is employed in very specific circumstances and need legal aid. As with a statutory merger, you must first establish a new company. Then, using separate agreements between the LLC and the new company, you must officially transfer assets, liabilities, and ownership interests. These transfers do not occur automatically, as they do in the other two procedures. Finally, similar to a statutory merger, the LLC must be properly dissolved.
IMPORTANT NOTE: The foregoing choices apply to both C companies and S corporations, but if you convert to a S company, you must additionally submit Form 2553 with the Internal Revenue Service.
With incorporation, new responsibilities arise.
So you’ve concluded that turning to a corporation is the best next step for your business. In addition to the benefits of this new company structure, you will have additional duties that you did not have as an LLC owner. Your incorporated business must now elect directors from its shareholders, and those directors must then choose the officers of the firm. The board of directors is required by law to have regular meetings and take minutes at each one. In addition, the new organisation must issue shares and perhaps meet extra financial reporting requirements.