Legal Question in Business Law in California

Re: Change S Corp to LLC

Strictly speaking, a corporation cannot be converted into an LLC (although general partnerships and limited partnerships can be converted into LLCs).

However, there are other ways to bring about the desired result.

One way is to create a new LLC, then merge the existing corporation into it.

A second way is to create a new LLC, then have the existing corporation's shareholders contribute their stock to the LLC in exchange for membership interests in the LLC. The LLC becomes a holding company for the corporation, which continues to exist as a 'subsidiary' of the LLC.

A third way is to liquidate the corporation by distributing all its assets to the shareholders as a liquidating dividend; then the shareholders contribute those assets to a new LLC in exchange for their membership interests.

Finally, the corporation itself may contribute its assets to a new LLC in exchange for the corporation receiving the LLC's membership interests. The corporation is then liquidated and the LLC membership interests are distributed to the shareholders as a liquidating dividend.

Whatever method is used, there will be tax and fee consequences. The IRS will consider the corporation to have been liquidated whichever of the above methods is used, and both the liquidating corporation and the shareholders may receive taxable income or gains. Further, for any year in which both the old corporation and the new LLC exist, each may be subject to the minimum franchise tax.

You would also need to consider any problems with the corporation's creditors and the assignment of its leases and other contracts to the new entity. When any business is liquidated, even for a benign purpose such as reorganization, it is fraud to repatriate assets to shareholders without paying the bills first.

The 'conversion' should not be attempted without both legal and accounting advice and guidance. Nevertheless, if there are substantial advantages to being an LLC, the 'conversion' can be accomplished at moderate cost and effort, especially if the business is relatively new and does not have substantial built-in (taxable) gains or a complex capital structure.

Re: Change S Corp to LLC

If your S Corporation hasn't yet done any business, then the solution to your problem may be easy. If your corporation has no creditors, yet, and hasn't done anything to incur any tax liability, yet, then you can simply abandon it. That is, stop filing annual Statements of Domestic Stock Corporation and tax returns. The State of California will suspend the corporation, but, as a practical matter, nothing else will happen. Remember, you can do this only if the corporation has no unpaid creditors and no tax liability. Then just start a new LLC and conduct your business under the name of the new LLC. One possible drawback is that the name you might want to use will have been taken by your now abandoned corporation. However, you probably could come up with another name that would satisfy you. Before you try to do any of this on your own, please consult with an attorney.