Thursday, June 25, 2015

Tax Law: The Process of Conversion from a Corporation to an LLC

By Justin J. Klatsky

The LLC is the preferred form for new entity formations in Florida. Profit corporation filings have declined from 170,207 in 2004 to 102,412 in 2014. That represents about a 40 percent decline. Annual new filings for partnerships of all types show an even more dramatic decline during this same period.  The only form of entity that saw an increase in new filings over this period in Florida was the limited liability company (LLC), with filings at 94,348 in 2004 and 197,286 for 2014, marking a 109 percent increase.  

The history of the LLC shows this to be a recent trend. There are many existing corporations and other business entities in Florida that, if formed today, would choose to be an LLC. This article will summarize the process of converting from a corporation to an LLC under sections 607.1112 through 607.1114 and 605.1041 through 605.1016, Florida Statutes, with attention to the tax aspects.

The first step of any conversion is a thorough review of the corporate books and records to ensure proper compliance with all requirements and procedures ― both internal and statutory. Of particular statutory concern is the triggering of appraisal rights under section 607.1302, Florida Statutes.

After a review of the corporate records, the corporation can then move forward with the required plan of conversion under section 605.1041, Florida Statutes, and in accordance with sections 607.1112 through 607.1114, Florida Statutes, which may involve certain notices, meetings, approvals, and written actions. 

Only after the proper plan of conversion has been adopted can the corporation file either a certificate of conversion under section 607.1113, Florida Statutes, or articles of conversion under section 605.1045, Florida Statutes, with the Department of State. Both include articles of organization for the new LLC.

Once officially converted, the LLC should then adopt an operating agreement that, at the very least, governs relations among the members, relations between the members and the LLC, the rights and duties of the management, the activities and affairs of the LLC, and the conduct of those activities and affairs, including accounting and tax concerns.

The previous summary addresses the requirements of state law. Federal tax consequences cannot be ignored, either. Even on the simplest conversions, purely for state law purposes, known as an F reorganization, IRC § 368 (a)(1)(F).  the correct tax forms should be filed with the IRS (such as Forms 8832 and 2553) to protect the entity from inadvertent termination of its tax treatment, which could result in severely adverse tax consequences, and to preserve its EIN. See IRM Section If the corporation seeks to change its federal tax treatment from a C corporation or S corporation to another form (such as a partnership or disregarded entity or from an S corporation to a C corporation), then careful tax analysis is needed to consider the tax consequences of these transactions.