Tax Secrets when Converting from an LLC to C-Corp

Generally, LLCs are simple to form, and sticking with these business structures for as long as possible can save you a lot of money in the long run. But what if your business starts to make money or decides to go public? The C-corp structure may be preferable at this time for a variety of reasons.

There are legal and tax implications to how you structure your company. While the Internal Revenue Code (IRC) and state codes recognize sole proprietorship, partnership, and corporation as well-established business structures, certain states have also allowed limited liability companies to operate. Because the Internal Revenue Code makes no provision for LLC taxation, the corporation can elect to be treated as one of the recognized business formations.

Why should you change your LLC to a C-corporation?

The decision to convert to a C-corporation is based on your company’s finances, preferred equity system, and growth objectives. The majority of entrepreneurs switch from an LLC to a C-corp for two reasons:

  1. Having a better likelihood of obtaining venture capital funding

As an LLC, raising funds from investors might be tricky. LLCs, unlike C-corps, have fewer liquidity events (such as IPOs and acquisitions), making them a riskier investments. Most people prefer to place their money into businesses to protect their investments and take advantage of more clear tax reporting.

  1. It’s easier to give staff stock options

You only have a few alternatives if you wish to provide your staff equity in an LLC. Profit interest units, which are a share of the company’s worth gained over a set period, can be given to employees, although they can be difficult to manage.

You can offer a variety of ownership options in a C-corp. Offering employees stock in your firm is a terrific way to recruit top people, increase retention, and position your organization for long-term success.

Taking care of your taxes after converting your LLC to a C Corporation

How do you address it on your tax return once you learn an investment has decided to change to a C Corporation? The quick answer is that you should seek professional assistance. There are so many intricacies and pitfalls that the cost of making a mistake and/or the discomfort of an audit may be greater than the money you believe you’ll save by doing it yourself.

However, if the cost of hiring a professional to handle it outweighs the investment, you may opt to handle the Schedule K-1 and conversion yourself. Keep in mind that the scenario will vary depending on the investment and the investor, so do your study for your situation. Having said that, there are a few common questions you’ll probably need to answer before you get started.

When converting an LLC to a corporation, the IRS takes a particular procedure:

When adopting non-statutory conversion, the IRS defined three precise procedures for converting an LLC to a corporation in Revenue Ruling 84-111.

Assets-over Conversion:

In exchange for receiving all of the corporation’s existing stock, the LLC transferred all of its assets and liabilities to a newly established corporation. The LLC was then terminated by the members receiving the whole equity of the newly constituted business.

Assets-up Conversion:

To begin, the LLC dispersed all of its assets and obligations to its members, allowing it to dissolve. Second, the members transferred all of the LLC’s assets to the corporation in exchange for all of the corporation’s outstanding stock and the corporation’s absorption of all of the LLC’s liabilities.

Interests-over Conversion:

In exchange for all of the corporation’s outstanding stock, the LLC members transferred their LLC interests to a newly established corporation. The LLC was dissolved, and all of the LLC’s assets and liabilities were absorbed into the corporation’s assets and liabilities. The IRS’s interpretation of Statutory Conversions and Statutory Mergers was not addressed in this opinion. A 2004 IRS advisory clarified the situation, stating that these types of conversions will be treated similarly to asset-over conversions by the IRS.

All LLC assets and liabilities to the corporation in exchange for stock in such corporation, and the LLC liquidate soon thereafter, distributing the corporation’s shares to its members. If all of the requirements are met, the conversion of a multi-member LLC to a Corporation will be able to qualify as a tax-free donation under IRC 351.

Tax Considerations

Consider the tax advantages and disadvantages of switching to a C-corporation. 

If you’re the only member of an LLC, you’re treated as a disregarded entity; if you’re one of many, you’re taxed as a partnership. The IRS considers you self-employed in both circumstances, which means you must pay Social Security and Medicare taxes on your business’s net earnings. 

You’re subject to double taxation like a C-corporation, which means you’re taxed at both the corporate and shareholder levels. As a result, even though LLC members are obligated to pay self-employment taxes, you may end up paying more in taxes as a corporation. 

If you elect to tax your LLC as a C-corporation, your LLC will be treated similarly to a corporation: the firm will pay corporate income taxes, but LLC members will only pay taxes on the income they get as a salary or dividend. Understanding the benefits and drawbacks of tax elections can be difficult, so speaking with a business attorney and accountant about your alternatives is a smart idea. 

Conclusion

Your Multi Member LLC is no different from any other person. Regardless of the reason for the conversion, such as a change in legal form or a change in check box, you should always speak with a tax specialist to determine the tax implications of your conversion. Remember that taxes, like death, are unavoidable, but you don’t have to suffer if you plan.

Converting a company from one business kind to another necessitates following the method laid down by the state of formation. All tax implications must be considered and met. It’s essential to see an accountant or tax advisor if you have any tax-related questions.