November 2, 2023

How to convert your company from a C-Corp to an LLC

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Selecting a business structure is one of the most important decisions you'll make when starting a company. The two most common options are LLCs and C-Corps. If you haven't started your incorporation, take our LLC vs. C-Corp quiz to get a personalized recommendation so you can make the best choice for your unique business.

While it's important to pick the right structure from the beginning, this decision isn't necessarily set in stone. If you reconsider your choice later on, you can file to convert to another business type.

In this post, we'll explain the process of converting your company from a C Corp to an LLC and when this might make sense for your company. But first, let's go a little deeper into the differences between the two structures.

LLCs and C-Corps

An LLC, or limited liability company, is the simplest and cheapest type of business you can incorporate in the United States. The phrase "limited liability" refers to the fact that LLC members are not personally liable for the obligations of the company. This is a critical protection for founders who want to separate their personal assets from those of the business.

LLCs are known as pass-through entities, which means that their income is taxed as the personal income of the members. Since the income is considered personal income, there is no need to pay corporate tax.

C-Corps come with similar liability protections, but they operate quite differently. First, such companies pay a corporate income tax, which is separate from the tax the owners have to pay for their share in the profits of the business.

Furthermore, while LLC ownership is split between the members, C-Corp ownership is divided in the form of shares. This creates a clear distinction — the managers, or officers, are separate from the owners, or shareholders. This distinction doesn't exist for LLCs since the members are both the managers and owners of the business.

US regulations require C-Corps to have a board of directors, hold regular board meetings, and even draw up company by-laws. LLCs don't face the same kind of reporting requirements, which makes them much easier to manage.

With that in mind, there are a few reasons you may want to consider converting from a C-Corp to an LLC. Maybe you don't want to keep up with the meeting requirements or you want to avoid corporate taxes. If you don't care about issuing equity, then you could be better off with a C-Corp.

Now, we'll go over three ways to convert your C-Corp to an LLC: statutory conversion, non-statutory conversion, and statutory merger.

Statutory conversion

Some states allow companies to file for this conversion by simply submitting a single application to the state Secretary of State. Each state is different, but a standard application will likely contain the following:

Approval from the board of directors
A plan of conversion
Approval from a majority of shareholders
A certificate of conversion approved by the directors

In addition to these documents, the Secretary of State’s office might also request a certificate of formation for the new LLC. The conversion will take effect once all these documents are submitted and approved.

Shareholders in your C-Corp will become owners/members of the new LLC, and the C-Corp will no longer be recognized as a legal entity. Similarly, your C-Corp's assets and liabilities will be transferred to the LLC.

It's really that simple — statutory conversions are the most straightforward way they to convert a C-Corp to an LLC. Unfortunately, this option is only available in some states.

Non-statutory conversion

Non-statutory conversion is significantly more complex. Rather than a one-off filing, this method requires a more involved procedure with several distinct steps. However, it may be your best option if your business is registered in a state that doesn't recognize statutory conversions.

The first step in this type of conversion is the incorporation of the new LLC. Once this has been done, a formal application is then made requesting the transfer of the assets and liabilities of your C-Corp to the LLC.

Unlike in a statutory conversion where this transfer means an automatic conversion of shareholders' stakes to LLC membership rights, a separate agreement has to be made for that transfer. Once this is done, the conversion is completed.

In states where this method is most common, there is a variation of the process offered to business owners where all they are required to do is register their new LLC, then proceed to liquidate and dissolve their C-corp.

This dissolution process involves filing a number of documents to the Secretary of State’s office which when approved means the conversion has taken effect.

While the end result is the same, the process is very different from what we saw with statutory conversions. Since the rules vary significantly by state, you'll need to check into the local regulations that apply to your business.

Statutory merger

A statutory merger shares some features of both statutory and non-statutory conversions. Some specifics are different in different states, but the general process is the same regardless of location.

First, you and other C-Corp owners must register the LLC which will be ‘merging’ with the C-Corp.

By doing this, the shareholders at your C-Corp become members of your new LLC. Once this has been carried out, you and these current shareholders at the C-Corp proceed to vote to merge your roles as stakeholders in the C-Corp with your LLC membership.

After this is done, the next step is a formal exchange of C-Corp shares by each former C-Corp shareholder for LLC membership rights.

This exchange process signifies the merging of both companies and after it is done, a certificate of merger is sent to the Secretary of State’s office along with any other document that they might request such as a formal dissolution of the C-Corp.

Unlike in a non-statutory conversion, once this process is carried out, there is also an automatic transfer of assets and liabilities from the C-Corp to the LLC.

Takeaways

Converting a C-Corp to an LLC can be complex, especially if your business is registered in a state that doesn't offer statutory conversions. However, there are a number of good reasons to go ahead with this move depending on your unique business situation.