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Converting an LLC to a Corporation: Tax Implications

Learn about the legal and tax issues involved

Avoid these tax consequences when converting from LLC to C-Corp

Creating a Limited Liability Company rather than a C Corporation can have its advantages when you’re just starting out with your business.

On the one hand, limited liability companies, or LLCs, are more flexible when it comes to conducting your business than C Corporations, or C-Corps, and are typically simpler to set up.

An LLC, like a C-Corp, can shield your personal assets from any lawsuits that might be brought against your company.

Although creating an LLC can be a particularly appealing option when your business is just getting started, you will have an easier time raising money from investors and giving staff stock options if you eventually change your LLC into a C-Corp.

Some drawbacks for C Corp businesses that LLC partners should take into account

A C-Corp must pay taxes, in contrast to an LLC. Each individual must pay income taxes on the money when the firm distributes its earnings (to pay its founders, staff, and investors). If your business has been functioning as an LLC, it can feel like a significant change because you’ll now be paying taxes twice.

Converting from an LLC to a corporation can be a difficult procedure. Everything is based on the state in where your LLC was created. Fast-track conversions are permitted in several states, including California, allowing you to change an LLC into a corporation in another state—typically Delaware. The process may be considerably more difficult in other states.

One further thing to keep in mind is that by submitting your papers on time, you can easily avoid a tax penalty.

Converting your business from LLC to C Corp can help you avoid tax penalties

Your partners will want to be aware of the following criterion if you are ready to convert from a partnership to a corporation:

As soon as the LLC ceases to exist, you must file a tax return for the LLC with the IRS.

The so-called short tax year return has a three and a half month deadline for filing and payment from LLC partners. Otherwise, in addition to the income taxes, each partner will be responsible for paying $195 every month.

All of the assets and obligations of your LLC might be easily transferred to your new C Corp. This is regarded as a tax-free donation under Section 351 of the Internal Revenue Code, and no gains or losses are allowed. You won’t be required to pay taxes if that is the case.

However, if your LLC contributes to the new C Corp more liabilities than assets, you will be required to pay taxes.

As an example, let’s assume that your LLC provides $50,000 in assets (cash, inventory, and accounts receivable) and $70,000 in liabilities (accrued expenses, debts). In essence, your LLC partners will have simply transferred a $20,000 debt to the new C Corp.

The LLC partners must pay income taxes on the $20,000 as soon as feasible since it will be considered income by the IRS.

It costs a lot of money each month to forget your paperwork, $195. Avoid having that occur to you!

We got you! 

Contact a professional startup tax provider and outsourced CFO team who can help you through the process if you need help converting your company from an LLC to a corporation or considering whether you should do it.