February 21, 2012Converting a Corporation into a Limited Liability Company
By Cliff Ennico
"My two brothers and I have run a successful service business for over 20 years, which we run as a 'C' corporation.
When we started this business, the limited liability company (LLC) was not available as an option for small business. We thought several times about converting our business into an LLC, but the time just never seemed to be right.
My brothers and I are getting on in years, and have started to think about selling this business down the road when it's time for us to retire. Our SCORE counselor suggested we convert to an LLC now because it will be much easier to find a buyer and get a favorable price than if we remain a 'C' corporation. Is he right?"
The short answer is . . . maybe.
A service business like this one -- with few hard assets but lots of happy customers generating income from their service contracts -- is usually better organized as an LLC or a subchapter "S" corporation, so that profits and losses "pass through" to the owners and there is no "double taxation" of corporate income.
There are two ways you can sell a business - you can either sell the corporation's stock, or the corporation's assets. Most business sales are structured as sales of assets. If you sell a C corporation's assets, the purchase price will be taxed twice - once upon the closing of the sale, and a second time when you distribute the cash to yourselves as shareholders. With an LLC, the purchase price is taxed only once.
If you sell your stock in the corporation rather than assets, there won't be "double taxation" of the purchase price (the proceeds go directly to you), but you likely will have a much tougher time finding a buyer at the right price, as stock sales create significant legal and tax disadvantages for buyers and they may negotiate the purchase price more aggressively to compensate for that.
There are two ways you can convert your C corporation into an LLC:
Option # 1: You can dissolve your corporation, distribute all of the corporation's assets to the shareholders (you and your brothers), then form a new LLC and contribute all of the corporation's assets to the new LLC.
Option # 2: You can form a new LLC and then merge the old corporation into the LLC (note: this option is not available in all states).
Under either option, you will be dissolving and liquidating your corporation, and you and your brothers will have to pay tax (at ordinary income rates) on the "built-in gain" from any of the corporation's assets that have appreciated in value since you started the business over 20 years ago. That's likely to be a very large number, and you will have to pay the entire tax when you file your final corporate tax return next March 15.
If your business has borrowed money from a bank, you may have to get the bank to approve the LLC conversion. If your business rents retail or commercial space, you may have to get your landlord's consent as well. Also, there's the pain of notifying all of your customers and suppliers of the change and reminding them to write their checks out to the new LLC.
Still, despite the tax and other headaches, converting to an LLC now may save you tons of money in taxes over the long run because your income from the business won't be "taxed twice," you will have much more freedom to operate the business the way you like, and (yes) it will probably be easier for you to find a buyer for this business when the time comes.
You will need a really good tax advisor to help you with this. When interviewing accountants, be sure to ask if he or she has any experience with "corporate reorganizations" in your state, and be sure to ask the following questions:
whether you will be able to use the same federal and state tax ID numbers after converting to an LLC (you have 20-plus years of excellent credit history, and you do not want to lose that by forming a new company and "starting from scratch");
if your business has net operating loss carryforwards (NOLs), whether you will be able to preserve them after converting (generally, you lose NOLs when there is a "change of control" of your company);
whether you should hire a professional advisor to "value" your firm so that you can rely upon independent professional advice if the IRS questions the amount of "built-in gain" your corporation reports on next year's tax return;
whether by converting in "stages" (i.e. forming the new LLC now and transferring the assets over time) you can spread the "built-in gains" tax over a period of years, making it less painful; and
whether your corporation qualifies for a subchapter "S" election, which will give you many of the benefits of an LLC conversion without the tax headaches.
Posted by Staff at 1:22 PM
Cliff Ennico (firstname.lastname@example.org) is a syndicated columnist, author and former host of the PBS television series "Money Hunt." This column is no substitute for legal, tax or financial advice, which can be furnished only by a qualified professional licensed in your state. To find out more about Cliff Ennico and other Creators Syndicate writers and cartoonists, visit our Web page at www.creators.com. COPYRIGHT 2012 CLIFFORD R. ENNICO. DISTRIBUTED BY CREATORS.COM Permission granted for use on DrLaura.com