Tax Implications of Converting From an LLC to a C-corp to Consider

When you’re just getting your company off the ground, forming a limited liability company rather than a C corporation can come with its fair share of benefits. 

Limited liability companies, or LLCs, are generally easier to set up and can give you more flexibility when it comes to operating your business than C corporations, or C-corps. 

Much like a C-corp, an LLC can also protect your personal finances from legal claims that may be filed against your business.  

Although forming an LLC can be a particularly attractive option when your company is in its very early stages, eventually converting it into a C-corp will make it easier for you to raise capital from investors and offer equity to employees.

What is the difference between LLCs and C-corps?

Starting an LLC can be simpler than a C-corp, but from a tax perspective, they are often seen as the more complex entity type. One of the reasons is that LLCs don’t pay taxes directly;this obligation is passed on to the members of the LLC. Each member of the LLC must allocate the proper ratio of profit and losses each year on schedule K1. Then each will use schedule K1 when filing their personal or corporate tax returns.

This pass-through structure of paying taxes for an LLC is one of the reasons C-corps are more favorable when raising capital, since C-corps pay taxes themselves vs. passing through the tax burden onto shareholders. 

Additionally, beginning in 2020, the reporting requirements for LLCs changed. From 2020 on, the capital account for each LLC member has to be tracked year over year, which has placed even more burden on LLC businesses and their tax accountants.

Timing Considerations When Converting from an LLC to a C-corp

If you’re planning to convert your LLC into a C-corp, timing will be key for any tax-related changes that need to happen. 

When you convert your business from a partnership or LLC to a corporation, you must apply for a new employer ID number that will be used for income tax and payroll tax reporting purposes. 

In some cases, this process alone can take days or weeks, so planning out the conversion ahead of time can go a long way.    

Additionally, your taxes may be impacted by the effective date of the conversion, since the LLC and C-corp would have two different employee ID numbers. For instance, if your LLC converts to a corporation on July 1, you must file two income tax returns — one for the LLC covering the pre-conversion part of the year and a corporate tax return covering the rest of the year.

You can avoid this hassle of filing two separate tax returns by planning for the conversion ahead of time and scheduling it to take place on December 31 at the end of a tax year.If you can do that conversion at the end of a year, you're simplifying some things from an income tax perspective because you can just cut off that old LLC return at the end of the year and then file as a corporation going forward.

Talk to an Expert

Converting your company from an LLC to a corporation and deciding whether you should do it can be tricky, so get in touch with an experienced startup tax provider and outsourced CFO team that can guide you through the process. 

Want to learn more about other common tax issues, such as what you should consider when hiring remote employees? Check out Pilot’s in-depth webinar on startup taxes.