As an entrepreneur, you’re probably more focused on giving your company a strong start now than changing it later. But it can definitely pay off to spend some time thinking about the future of your business and choosing the best corporate structure to allow for flexibility.
Despite all your careful preparations, an expanding company can outgrow the original plans of its owner, which may necessitate converting the business into another type of entity. Making this change can become more or less complicated depending on which entity you originally chose.
Smart Business Network contributor Mark Klimek says that filing an LLC helps give a company the flexibility it may need to adapt further down the road. That flexibility is probably one of the reasons that many small business owners are choosing to start companies using an LLC format. After all, one of the best characteristics of entrepreneurs is that they are always thinking ahead! Here are some ways that LLCs offer flexibility for the future of your company.
Examples of Changing Entities
Let’s say you planned on starting an LLC in Florida as a sole proprietor, and you then expanded the business to include various members along the way. Your LLC now needs to file as a partnership, which can be as easy as creating a Partnership Agreement.
Now let’s say your business explodes and you want to add stockholders. A C Corp might be the right option for you at this point. However, a C Corp is the most intricate entity type; it requires you to create Articles of Incorporation that explain how your business is run and submit this to your Florida Secretary of State. Next you’ll need to write bylaws, possibly create stock certificates and schedule annual meetings with your shareholders.
(Note: Remember that the policies, articles, cost and regulations for forming a C Corp vary from state-to-state! Your local Small Business Administration office can be a good resource for researching this.)
How to Convert an LLC Into an S Corp for Tax Purposes
Converting an LLC or S Corporation can often be done without any major tax complications, Klimek writes. But to perform the process the opposite way — turning a C corporation into an LLC — generally ends up being a taxable conversion. Here, we’ll explore the process of changing an LLC to an S Corp since it’s one of the more common entity changes.
Let’s assume that you want to change your LLC into an S Corp. With an LLC, taxes are passed through your personal income tax return. With an S Corp, though, any income, losses, credit and deductions are passed to the individual shareholders for federal tax purposes.
There are some very specific guidelines that you must follow to become an S Corp. For example, you must have fewer than 100 members that are considered shareholders. Those shareholders can be individuals and certain types of trusts and estates, but not partnerships, corporations or nonresident aliens. Additionally, regulated businesses such as financial institutions, insurance companies and international sales corporations cannot choose to be S Corps.
According to the IRS, “a domestic LLC with at least two members is classified as a partnership for federal income tax purposes unless it files Form 8832 and affirmatively elects to be treated as a corporation. And an LLC with only one member is treated as an entity disregarded as separate from its owner for income tax purposes (but as a separate entity for purposes of employment tax and certain excise taxes), unless it files Form 8832 and affirmatively elects to be treated as a corporation.”
Simply put, filing Form 8832 and submitting it to the IRS will change the entity of your company. However, if you originally classified your LLC to be taxed as a corporation, you are not required to re-submit Form 8832. If your LLC was taxed as a partnership or sole proprietorship and you wish to change it to an S Corp, you must file Form 8832 and mark box 6a to choose being taxed as a corporation.
Mergers and Conversions
There are several other ways you can change the structure of your LLC after it’s formed. Here are just a few you might consider:
Many states have created a more streamlined approach to changing your entity type by just filing a few forms with the secretary of state’s office. After creating a plan of conversion that is approved by the LLC members, you can file a certificate of conversion and submit it to your secretary of state. People who were once your LLC members are now considered to be stockholders, and your assets and liabilities transfer to your new corporation.
If your state does not allow for statutory conversions, you may need to go this route. While the process varies by state, it usually includes forming a new corporation where your members become stockholders, having your LLC members approve the changes, having members change their membership rights to convert into shares and informing your secretary of state of these changes.
A nonstatutory conversion is the most expensive and complicated way to change your entity. This involves forming a new corporation, transferring assets from the old LLC to the new entity, formally exchanging LLC membership interests for corporation shares, formally liquidating the previous LLC and finally dissolving it.
There are countless reasons you might want to change your business entity, and the ways to do it vary greatly. Most business owners already have a million things on their to-do lists, but luckily you can leave the legal matters for those who know how to do it right. Incfile has a team of experts that can help you manage your company regardless of which entity you initially choose or how you want to alter it later.
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