Planning to Convert Your C Corporation to an LLC
If you’ve decided that the best way to advance the goals of your business is to convert your C corporation to an LLC, you should proceed with great care. Converting a C corporation to an LLC has the potential to cause severe negative tax ramifications for your business. In certain situations, though, making the move from C corporation to LLC can be beneficial, but you should engage in careful planning to carry out the conversion process, since the tax code contains many rules that may guide you in deciding when to make your conversion.
There are many reasons you might choose to convert your C corporation to an LLC. For example, converting to an LLC may help you lower the taxes your business owes while retaining liability protection. Whatever your reason, it is important to realize that making this conversion is generally a double-taxable event. The most straightforward way to achieve this conversion is to liquidate the corporation. This is done by transferring the corporation’s assets to the shareholders. The shareholders then take these distributed assets and contribute them to the new LLC. This method can be expensive from a tax debt standpoint. A straight liquidation is treated as if the corporation sold all of its assets, including its goodwill, to its shareholders at fair market value. This will result in double taxation, since the corporation will have to pay tax on the gain it realized in terms of the fair market value of the assets minus the corporation’s basis in those assets, while the shareholders will pay tax on the gain they realized, which is calculated as the fair market value of the distributions they received from the corporation minus their basis in their stock.
Given these rules, an economic downturn can represent a real opportunity for a C corporation looking to convert to an LLC. During a downturn, the asset values are at low ebbs, meaning that the gain the corporation realizes, and the gains the shareholders realize, are lessened.
It is also important to understand the scenarios in which a C-corporation-to-LLC conversion may be very expensive. If your corporation’s assets have accumulated substantial gains, converting to an LLC through liquidation could create both large and immediate tax obligations. Also, if your corporation is a very successful service-oriented business, you’ve probably accumulated a large amount of goodwill. As mentioned above, your goodwill must be distributed along with all of your corporation’s other assets in a conversion achieved through liquidation. Large amounts of goodwill would mean larger gains and larger gains taxes for both the corporation and the shareholders.
Converting your C corporation to an LLC involves careful planning and a keen understanding of both your business’ assets and the tax code. For skillful and experienced assistance making these planning decisions, talk to the tax attorneys at Samuel C. Berger, P.C. and CPAs at S.C. Berger, P.C. To consult our attorneys and CPAs, contact us online or call (201) 587-1500 or (212) 380-8117.