During the life of your business, things are bound to change. For example, in the early stages of your business, you may have preferred to keep things simple with an LLC. But as your business and expectations grow, you may need to change your business structure. After all, what may have worked for your business during the first few years of its existence may not be optimal for you now.
If you’re considering changing your company from one business structure to another, there are a few things to keep in mind. The procedures themselves are not necessarily difficult or complex, but will typically involve some legal steps, such as a merger or the dissolution of one entity and the creation of a new one.
As expected, there can be significant tax implications involved with these moves, so seek the advice of an accountant or tax advisor to determine what’s best for your business.
Here are some of the common scenarios where you might want to change your business structure:
Scenario 1: Convert a C Corporation to an S Corporation
For many small businesses, the C corporation ends up being too cumbersome and costly. Maybe you formed your company as a C corporation and quickly discovered what “double taxation” means. Maybe your tax advisor mentioned you could lower your taxes with the pass-through tax treatment of an S corporation.
Fortunately, converting a C corp to an S corp is one of the easiest changes to make; it can be done with a single tax form.
If you have a C corporation, you can elect S corporation status by filing IRS Form 2553 no more than 75 days from the date of incorporation, or no more than 75 days from the start of the current tax year. This means that if your C corporation existed on January 1 (and you’re a calendar-year taxpayer), you’ll need to file IRS Form 2553 by March 15 to receive S corporation treatment for the current tax year.
It’s important to note that the IRS places certain restrictions on who can form S corporations. For example, all shareholders in an S corp must be individuals (not LLCs or partnerships) and legal residents of the United States.
Scenario 2: Convert an LLC to a C Corporation
If you’re like most small business owners, when you started your company, you weren’t looking for outside investors or thinking about a stock option plan. You just needed a low-frills, easy way to protect your personal assets and track company ownership. Then perhaps your business grew, opportunities emerged, and the time came to consider VC funding.
Before you bring in outside investors, you’ll need to switch your LLC to a C corporation, as it can be more complicated to try converting your business after others are involved in company ownership.
The particular steps required to convert an LLC to a corporation depend on the corporate laws in whatever state the LLC is registered. For example, in some cases, you’ll need to create a new C corporation and then make the original LLC a subsidiary of the newly formed C corp. This is a relatively standard process, and your attorney or online legal filing service will be quite familiar with the steps needed. In fact, most startups and businesses find that this conversion is the simplest part of their Series A round or other financing!
Scenario 3: Change a C Corporation to an LLC
If you’re a non-U.S. citizen who formed a corporation and is burdened with double taxation, you’ll need to change your C corp into an LLC to take advantage of pass-through taxation. That’s because the IRS requires owners of an S corp to be U.S. citizens.
Most states don’t allow C corporations to restructure as an LLC. As a result, you’ll need to form an LLC and dissolve the C corporation. Just like with changing from an LLC to C corporation, this is a common process that your attorney or online legal filing service can guide you through with relative ease.
There’s no reason to stick with a business structure that doesn’t work for your business or finances anymore. Remember that it’s always possible to convert your business structure once your circumstances change.