Preparing for Growth: Making Your LLC a Corporation

September 14, 2010

In selecting a business entity, the focus is often on the limited liability, single level of taxation, and informality offered by a limited liability company (LLC). However, LLCs provide an additional benefit: relatively simple conversion to other business entities, especially the corporation.

In 2002 legislation was enacted to allow LLCs to be converted to corporations with a single step instead of the multi-step structure that had been necessary. Wisconsin law now allows an early stage enterprise to be organized as an LLC and later converted to a corporation with relative simplicity to take advantage of the more sophisticated financing strategies that typically require a corporate form such as venture capital investment or a public stock offering.

To convert an LLC into a corporation, the LLC must submit to the Wisconsin Department of Financial Institutions a certificate of conversion, a plan of conversion, a statement indicating the plan was approved in accordance with the law of the jurisdiction governing the preconversion LLC, and a statement identifying the registered agent and office before and after the conversion.

The plan of conversion must include the name, the form of the entity, and the jurisdiction governing the LLC both pre and post conversion. It must also detail the terms and conditions of the conversion including the terms for converting the membership interests into shares of the corporation. Furthermore, the plan must include a copy of the articles of incorporation for the new corporation.

After conversion the new corporation remains subject to all liabilities incurred while organized as an LLC. The new corporation also will continue to be vested with title to all its prior real estate as long as instruments of conveyance are recorded in each Wisconsin county where the LLC owned real estate to reflect the conversion of the LLC to a corporation. Such a conveyance is not subject to a transfer fee. The articles of incorporation included in the plan of conversion become the articles of incorporation governing the new corporation.

While a conversion is straightforward as a corporate law matter, the tax implications of such a transaction are less so. However, in general, a conversion of an LLC into a corporation will be treated as follows. First, there will be a deemed distribution of assets followed by a recontribution to the corporation. The deemed distribution may be taxable if the cash and accounts receivable distributed by the LLC are greater than each member’s basis in their membership interest.

The recontribution will be a tax free “transfer to a corporation controlled by transferor” under Internal Revenue Code § 351 if the owners of the LLC own at least 80 percent of the corporation. The assignment-of-income doctrine does not override § 351 so that receivables and payables transferred with the conversion will be reported by the transferee corporation. Limitations apply where receivables are accumulated or payables prepaid in anticipation of the conversion. Additionally, holding period, basis, and recapture issues may arise in conversions but are best analyzed on a case by case basis.

After a conversion, the new corporation will require a new Employer Identification Number and the contributed assets will be depreciated as though they were newly acquired from a third party. Essentially, the business starts over.

It is relatively easy to anticipate conversion of an LLC to a corporation by including appropriate provisions in the LLC’s operating agreement. One of our business attorneys can help you in evaluating and implementing the best legal structure for your business.

To subscribe to email alerts from Axley Law Firm, click here.