Why is converting a corporation to a LLC beneficial?
LLCs are generally better asset protection entities than corporations. A major reason for this is because a judgment creditor may levy upon the debtor’s stocks in a corporation. At times where a small corporation is involved, a judgment debtor may possibly stop the corporation business and liquidate corporate assets. Federal S-Corp laws and Florida corporate statutes have slowly changed to accommodate the different features of small businesses; however, these laws and statutes did not completely evolve to provide asset protection for stocks held by shareholders with personal judgments against them. Judgment creditors may take shareholder’s stocks to satisfy their judgment. Judgments may arise from lawsuits entirely unrelated to the business. If such an event were to occur, a judgment creditor may vote and exercise the same powers as the original shareholder had. This kind of power is sometimes used to force a liquidation of the business and a sale of its assets to satisfy the judgment, sell the stock to a competitor or even demand inspection of the corporation’s books. On the other hand, where there is a LLC, the judgment creditor’s remedy is generally limited to a lien on distributions, if any, and the creditor may not stop the LLC operations or force the sale of the LLC’s assets. Unless otherwise provided in the LLCs governing documents, the LLC statute specifically prohibits the levy of a LLC owner’s interest by limiting the judgment creditor to a charging order remedy. This means that the judgment creditor would not have the right to exercise the owner’s vote; it only has the right to receive any distribution, if any, the owner would have been entitled to in a properly structured and maintained LLC.
What kind of changes does my business face when converting my corporation to a LLC?
Since the “new” LLC is essentially the same creature as the original corporation prior to the conversion just now in a different form, there is no need to transfer licenses, assets, or contracts. If converted properly, the LLC is for all purposes and by operation of law the same entity as the corporation and the “new” LLC may even keep the same tax identification number. The conversion automatically transfers your corporation’s assets and liabilities to the “new” LLC. Only one business entity is involved and you do not need to separately form an LLC before the conversion can occur. On the same note, there is also no need to dissolve your original corporation. Under Florida’s conversion statute, the original corporation involved in the conversion is simply considered by default to continue its existence in the form of the “new” LLC.
How do I convert my corporation to a LLC?
A Florida corporation can be converted by consulting with an experienced attorney who can carefully draft the necessary documents beyond the public filing with the Florida Department of State. It is strongly advisable to retain an experienced attorney in creating a Plan of Conversion and assistance in the additional execution of an Agreement to Convert and an Operating Agreement, as well as Board Resolutions and Shareholder Consents of the converting Corporation- all of which need to be catered specifically to your business’ needs. Florida’s conversion statute requires that your corporation approve the Plan of Conversion before you file the Certificate of Conversion with the Florida Department of State. You must make sure all shareholders entitled to vote are notified of this corporate transaction.
What happens if the conversion is not handled properly?
If the conversion of the corporation to the LLC is not handled properly, an improper conversion may create various unforeseen complications and long-term consequences. One such example is that the IRS could treat the conversion as if the corporation had liquidated and distributed its assets to the owners who then contributed the assets to a “new” LLC. This liquidation may lead to taxation of the hypothetical “gains” of any appreciated assets. Nevertheless, a properly structured conversion may avoid this and other potential legal and tax complications. You will further need to take care of all the tasks normally associated with creating and maintaining a new LLC such as having an Operating Agreement drafted for the LLC, holding required LLC meetings, keeping proper minutes of meetings, keeping LLC finances separate from personal finances, using the official LLC name on your business documents; and filing the required annual report to the state. As in the case of an S-Corp to LLC conversion, care must be taken when drafting the Operating Agreement and other necessary legal instruments. Having the proper legal instruments drafted by an attorney and consulting with an experienced tax specialist is an extremely important step in properly converting the corporation to a LLC since legal and tax issues must be addressed in advance to successfully complete the conversion. The small amount of investment made now to obtain a large amount of protection for your business later is always a smart and worthwhile business decision for your future business success.
Disclaimer: This article is not intended to be legal advice. Legal advice depends on each and every person's particular circumstance. This article is for informational purposes only and must not be used for avoiding any penalties that may be imposed under the Internal Revenue Code. Arora Law Firm and Radhika Arora, Esq. specifically disclaim any responsibility for positions taken by readers in their individual cases or for any misunderstanding on the part of readers of this article or publication.