Avoid Expensive Tax Consequences by Converting Your Entity from an LLC to a C-Corp

The most traditional way that small businesses, entrepreneurs, and startups put their names on the map is via the formation of a limited liability company (LLC).  Creating an LLC makes sense if your business is owned by one person or only a couple partners.  Operating an LLC also allows all business members to have more flexibility.  

When viewed from the tax angle, the LLC becomes even more attractive as any business income is treated as the income of the respective business’ owners.  Simply put, partners and owners do not pay separate taxes for business income.  An LLC is arranged so that business taxable profits and deductible losses are passed through to the owners, who are all considered business partners.  

Although simple in concept, down the line, there might come a time where an LLC arrangement is no longer the right vehicle for your business.  It’s at this point that you should consider converting your business into a C Corp from an LLC.  At Thomas Huckabee CPA, we will make your transition a lot easier.

Three Circumstances When a C Corp Conversion is the Best Option

1. A Desire to Attract Venture Capital

Venture Capitalists seek out opportunities to invest in C Corps.  C Corps permit investors to create “preferred shares” of your business’ stock.  Furthermore, C Corps allow for a consistent legal structure.  This consistent legal structure makes it significantly more simple to compare companies to companies.  

2. You Need an Accelerator to Boost your Startup

Accelerators, also known as incubators, typically require their participants incorporate as a corporation.  The reasoning behind this is that it is far easier to give others equity than not to…and that is precisely how accelerators generate income.

3. Equity is Needed to Distribute to your Employees

The structure of a corporation is such that it makes the business process practically seamless if your business wants to later divvy out shares to its employees.  In an LLC, only partners can own any portion of the business.   

Potential C Corp Downsides

Let’s just outline a few negatives relating to C Corp conversion:

  • A C Corp pays taxes- when your business distributes income to investors, founders, employees or the like, each one of those individuals must pay taxes on those funds in addition to the personal taxes they owe.  Under LLC regulations, recall that pass through income is treated as personal income and only one set of taxes need to be filed.
  • The conversion process for converting to a C Corp from an LLC is cumbersome and extremely complicated.  Laws for conversion differ from state to state.
  • There is no exception for not filing your paperwork on time.

Avoiding any Conversion-related Tax Penalties

If there is one regulation that you cannot make the mistake of not following it is the IRS regulation that you immediately file your LLC tax return the instant it ceases to exist.

Former LLC partners/owners have three and a half months to pay and file a short tax year return.  In the event this does not occur, all partners will be subject to a monthly $195 ticket, on top of the personal taxes they already owe.  

One caveat here is that, if your LLC can simply convert all of its assets and liabilities to a brand new C-Corp, IRS Code Section 351 will allow this transfer to be considered a tax-free contribution.  Should this status be granted, no payment of taxes is necessary.  Please note that there is no way to avoid paying taxes if your LLC contributes fewer assets than liabilities to your C Corp.  

Conclusion

Prior to considering the C Corp conversion, you must contact your accountant and attorney.  Most accountants are very well trained in the C Corp conversion process but you might have to search out an attorney who specializes in corporate law.  At  Thomas Huckabee CPA, our accounting and tax expert teams will be there for you to make sure you have a team on your side to assist in tax related issues.   

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