august2022 - 25

FEATURE
required in the articles of incorporation varies by
state, but in general, includes:
* Corporation's name
* Address of the corporation's principal office
* Name and address of the corporation's registered
agent
* Business purpose
* Whether the corporation is organized on a stock or
non-stock basis
* If stock basis: the initial classes of stock, number of
authorized shares, and par values of shares
* Name and address of each incorporator
* Name and address of each member of the initial
board of directors
* Effective date requested
The C Corp may also be required to file corporate
bylaws (similar to the operating agreement) and an
annual report with the state to keep the government
apprised of any significant corporation changes.
DIFFERENCES IN TAXATION
Although separated legally, LLC members and the
company are (by default) considered the same
tax-paying entity by the IRS. The LLC's profits and
losses pass through to the owners' personal income
tax returns. Also, all profits are subject to selfemployment
taxes (Medicare and Social Security).
In a C Corp, where the business owners are
company employees, the corporation is a separate
tax-paying entity. When the C Corp makes a profit, it
is taxed on that income. Then, the business owners
are taxed on the portion of business income that
is paid to them as salaries-often referred to as
" double taxation. " In a C Corp, the corporation
is responsible for remitting half of the payroll
taxes and taking the other half from employees'
paychecks. If shareholders receive dividends from
the corporation, the shareholders claim the money
as income and pay the appropriate taxes.
The Tax Cuts and Jobs Act of 2017 (TCJA) gave
C Corps a flat 21 percent tax rate which may be
advantageous for some business owners. In addition,
many business tax deductions are only allowed for
C Corps, which may be a reason to convert an LLC
to a C Corp.
However, LLCs can file taxes as C Corps and not
have the company's profits pass through to their
personal tax returns. For LLCs keeping a substantial
part of their profits in the business (retained earnings),
electing to be treated as a C Corp allows for
paying lower salaries and fewer taxes.
Alternately, LLCs and C Corps can elect to be
taxed as S Corporations. S Corps are corporations
electing to pass corporate income, losses, deductions,
and credits to their shareholders for federal
tax purposes. The S Corp election allows shareholders/owners
to avoid double taxation and potentially
pay less in payroll taxes by dividing income into
wages and dividends. However, not all LLCs can elect
S Corp taxation. Companies must:
* Be a domestic corporation
* Have only allowable shareholders:
* Can be individuals, certain trusts, estates and
* All shareholders must be U.S. citizens
* Have no more than 100 shareholders
* Have only one class of stock
To become an S Corp, the corporation must
submit Form 2553, Election by a Small Business
Corporation, signed by all the shareholders.
So far, the reasons for converting from an LLC to
a C Corp or vice versa can be attributed to management
organization and some tax benefits. However,
the primary reason your client may want to convert
business structures is the difference in investment
opportunities.
INVESTMENT DIFFERENCES
For many business owners attracting more investors
is critical to their company's growth. How and what
role the investors play are the crucial differences
between LLCs and C Corps.
Bottom line: LLCs cannot sell stock of any kind.
To accept investment money in an LLC, the investors
must be added as LLC members, and the company
has to resubmit its articles of organization with the
new members' information. State laws allow LLC
members to be individuals, corporations, partnerships,
and other LLCs. LLC members are not required
to actively participate in the company's operations.
The LLC's operating agreement must record each
member's capital investment in the company. Unless
otherwise stated, the IRS assumes the investment
percentage proportions of profits and ownership.
However, LLCs are granted the flexibility to proportion
profits and ownership as they like; for example,
more may be attributed to active members. Passive
members are not required to pay self-employment
taxes on their share of the profits.
Conversely, C Corps can sell unlimited stock or
shares, including offering employees stock options.
If your client plans to take the company public or
offer employees equity in the business, the company
must be structured as a C Corp. Investors typically
prefer to put money into a C Corp because of the
opportunity for growth, the lack of taxation on
business income, and the protection from personal
liability.
STEPS FOR STRUCTURE CONVERSION
The process for an LLC to convert to a C Corp or
vice versa varies by state. However, in most states,
the corporations can file a " Statutory Conversion. "
In states that allow statutory conversions, the
procedure is as follows:
* Create a plan of conversion, which must be approved
by all LLC members and shareholders
* File a certificate of conversion and articles of
incorporation/organization
* Pay the filing fee
In some cases, the state may require the company
to obtain a new Federal Tax ID Number or EIN
(Employer Identification Number). If the state doesn't
allow statutory conversions, the LLC or C Corp must
dissolve the company and start the corporation from
scratch. Dissolution requires assets and liabilities
to be " dissolved " and reformed. If the state allows,
a " Statutory Merger " can help keep the LLC from
starting over.
In a statutory merger, the members approve a
merger plan and swap their allocated membership
interests for shares in the corporation. Then a
certificate of merger (or whatever the state requires)
must be filed with the secretary of state's office to
finalize the process.
To convert from an LLC to a C Corp, your client
may be able to form a new C Corp and then make
the original LLC a subsidiary of the newly formed
C Corp. It is less common for a C Corp to convert
to an LLC as the C Corp is taxed on the sale of its
assets. Then the shareholders are taxed on those
profits-again leading to double taxation.
Your clients have much to consider before
converting their business structure. But with your
guidance, a change may open the door to additional
opportunities to help their companies grow. ■
Nellie Akalp is a passionate entrepreneur, small business
expert, and mother of four. She is the CEO of
CorpNet.com, a trusted resource for Business
Incorporation, LLC Filings, and Corporate Compliance
Services in all 50 states. Nellie and her
team recently launched a partner program for
accountants, bookkeepers, CPAs, and other professionals
to help them streamline the business
incorporation and compliance process for their clients.
More info at: CorpNet.com/partners.
AUGUST 2022 ■ www.CPAPracticeAdvisor.com
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august2022

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