The Difference Between a Business Entity Statutory Conversion and Business Domestication

Quite often, my team at CorpNet fields a lot of calls and emails from business owners that want to make changes to their companies via business filings specifically wanting to file for a statutory conversion. Some changes are rather simple and straightforward, while others are more significant and substantial. Two of the more involved type of changes some clients request are “statutory conversion” and “business domestication.” And sometimes, people confuse the two. So, I thought it would be helpful to share some general information about what they are and how they’re different. Realize that both statutory conversions and domestications have legal and tax ramifications, so while you can gain some basic knowledge from this article, it is no substitute for expert guidance from a licensed attorney and tax advisor.

Statutory Conversion vs. Business Domestication

In short form, below are what each of these terms means:

  • Statutory Conversion – Changing from one business entity type to another
  • Business Domestication – Moving a business entity to a different state, changing its residence (a.k.a. changing its domicile)

Statutory conversion and domestication are two distinct concepts.

Let’s talk about each one in more detail…

Statutory Conversion

Many states now allow businesses to convert to another entity type without completing dissolving the company and starting a new one.

First, let’s discuss why business owners might decide to change the legal structure of a company?

Different factors may influence that decision including the following and more:

  • Personal liability protection
  • Tax rates and allowable deductions
  • Bringing on (or removing) additional owners
  • Management flexibility
  • Potential to raise capital for growth and expansion

The steps and documents involved in doing a statutory conversion vary from state to state and depending on a business’s current entity form and the one it will be converting to.

The steps/documents involved in doing a statutory conversion usually include:

  1. Write a Plan of Conversion.
  2. Get approvals by the governing bodies (e.g., shareholders, board of directors, LLC members) of the entity.
  3. Complete the formation document for the new entity type (e.g., Articles of Incorporation or Articles of Organization).
  4. Complete a Certificate of Conversion for the post-conversion entity.
  5. File the formation document and certificate of conversion (and filing fees) with the state.

Because statutory conversions aren’t available in all states and the process varies in the states that do allow them, it’s critical to get professional legal guidance to ensure you understand the requirements.

Examples of Statutory Conversions

How to Change from an LLC to a C Corporation

As a company grows, it’s common that so does its need to raise capital to fuel additional growth. That’s why we see a lot of LLCs that eventually convert to corporations. The corporate business structure allows for a company to attract venture capitalists and raise money through selling stock.   For the purposes of this article, let’s look at converting an LLC that’s taxed as a partnership to a C corporation.

Where states allow statutory conversions, the procedure is relatively simple:

  1. Prepare a plan of conversion.
  2. Have LLC members approve the plan of conversion.
  3. File a certificate of conversion and articles of incorporation.

Sometimes, the conversion process also requires getting a new EIN (Employer Identification Number) for the corporation.

If the state doesn’t allow for conversions, then the LLC will have to dissolve and start a new company as a corporation or complete a statutory merger. The latter is more complicated than a statutory conversion but less involved than entirely closing the business and starting a new one.

A statutory merger involves changing the LLC to a corporation, and the LLC’s members become shareholders in that corporation. After approving a plan of merger, those individuals swap their membership interests in the LLC for shares in the corporation. A certificate of merger (and any other state-required documents) must be filed with the Secretary of State office to finalize the process.

Beyond the conversion and business formation documents, other corporate compliance elements must be completed, too, when converting from an LLC to a C corp. For example:

  • Drafting bylaws
  • Electing corporate officers and a board of directors
  • Holding a board meeting
  • Issuing stock certificates
How to Change from a C Corporation to an S Corporation

Another request we get from CorpNet clients is to change a C corporation to an S corporation. One reason for this is to simplify corporate compliance obligations. Another is to avoid the “double taxation” that C corps undergo as corporate income is taxed at the corporate rate and then again at the individual level when distributed as dividends to shareholders. A tax advisor might suggest that the pass-through tax treatment of an S corporation would be more beneficial.

The S corp is a tax election rather than an actual entity change so that it can be accomplished easily with a single tax form, IRS Form 2553. There is some timing to consider for making the S corp election:

To receive S corp tax treatment for the entire year, a C corporation must file IRS Form 2553 no more than 75 days from its date of incorporation or no more than 75 days from the start of the current tax year. So, if a C corporation was formed on January 1 (and its tax year is the calendar year), it must file a 2553 form by March 15 to receive S corp tax treatment for the current tax year.

Note that the IRS has restrictions on what corporations can elect S corp status.

To qualify, a corporation must:

  • Be a domestic corporation
  • Have no more than 100 shareholders
  • Have shareholders that are individuals, certain trusts, and estates (they may not be partnerships, corporations, or non-resident aliens)
  • Have only one class of stock
  • Be an eligible corporation (i.e., not be ineligible as are certain financial institutions, insurance companies, and domestic international sales corporations)

Note that an LLC can elect for S Corp status while retaining the LLC entity structure. To do this, it must first file IRS Form 8832 (Entity Classification Election form), to be recognized as a corporation for tax purposes. Then it must submit Form 2553 to elect for S Corp tax treatment. The advantage to LLC members is that only their wages and salaries paid to them from the LLC have self-employment taxes imposed. Generally with an LLC “disregarded entity,” self-employment taxes (Medicare and Social Security) are applied to all business profits.

How to Change from a Corporation to an LLC

Corporations formed by non-U.S. citizens may at some point discover that the corporate double taxation scenario is hurting them financially. But unfortunately for them, they are not eligible to elect for S Corp status. So, how can they take advantage of pass-through taxation? The answer: convert to an LLC.

Some states allow for statutory conversions from a corporation to an LLC, but others do not. It’s essential for business owners to check with the state (and I recommend talking with an attorney) to identify the options. Where a statutory conversion isn’t possible, a statutory merger might be. Or it might be necessary to dissolve the corporation and form an LLC from the ground up.

Business Domestication

Domestication involves transferring an LLC or corporation’s charter to a different state—i.e., changing the business’s domicile (residence).

Sometimes, people confuse domestication with foreign qualification. So let me take a moment to explain the difference:

  • Domestication is moving the business to another state. When completed, it no longer exists in the state where it was initially formed.
  • Foreign qualification is registering a business in another state (or states) beyond the state in which it is already registered. With foreign qualification, the business retains its residence in its original state.

Not every state allows domestication and those that do have their own rules and process. With that in mind, it’s vital that business owners check with the Secretary of State office in the state to which they want to domesticate. If domestication isn’t an option, then the business will need to form the company anew in the state to which it wants to move and dissolve the company in the state it’s moving from.

Basic Steps to Domesticate an LLC or Corporation to a New State

While the requirements vary from state to state, the domestication process generally involves the following steps:

  1. Apply for domestication in the new state.
  2. Dissolve the business in the state where it was chartered originally.

A word of caution: Be wary of filing for dissolution before the domestication documents have been accepted. How devastating would it be to find out that you have no active business? That could potentially happen if the new state rejected your domestication application and you had already closed your business in your original state.

Benefits of Business Domestication

An alternative to forming a corporation in a new state and dissolving the existing corporation, domestication offers some advantages:

1. It has fewer tax consequences (mainly because it avoids liquidating the assets of the LLC or corporation when ceasing operations in the original state).

2. The company retains its credit history, thus giving investors, banks, and vendors more confidence in lending money or doing business with it.

For companies that are foreign qualified to do business in another state (or states), they may be able to change their state of incorporation to a host state through domestication. In other words, they may be able to change jurisdiction rather than completely dissolve in the home state and re-register in the host state.

Domestication Documents

States usually ask for the following documents when a business applies for domestication:

  • Articles of Domestication for the state to which the business is relocating
  • Certificate of Good Standing (from the business’s original domicile state)
  • A copy of soon-to-be-filed Articles of Dissolution (for the charter state)
  • A Certificate of Good Standing (from the charter state’s Secretary of State)

A Word About Statutory Conversions, Domestications, and Business Compliance

Regardless of whether a company is doing a statutory conversion or domestication, it must make sure it fulfills all federal, state, and local business compliance requirements to operate legally and maintain good standing. Different entity types have different compliance obligations, and those responsibilities vary by state and jurisdiction, as well.

Before making any changes to a business that will have legal or tax implications, it’s wise to consult a lawyer and accounting and tax professional for insight and guidance.

After getting that advice, CorpNet is here to help with all your business formation and compliance filings—including statutory conversions and domestications. Contact our filing experts today to get started!

2019-01-16T15:31:43-07:00 January 22nd, 2019|Categories: Growth and Expansion, Startup and Launch|

About the Author:

Nellie Akalp
Nellie Akalp is an entrepreneur, small business expert, speaker, and mother of four amazing kids. As CEO of CorpNet.com, she has helped more than half a million entrepreneurs launch their businesses. Akalp is nationally recognized as one of the most prominent experts on small business legal matters, contributing frequently to outlets like Entrepreneur, Forbes, Huffington Post, Mashable, and Fox Small Business. A passionate entrepreneur herself, Akalp is committed to helping others take the reigns and dive into small business ownership. Through her public speaking, media appearances, and frequent blogging, she has developed a strong following within the small business community and has been honored as a Small Business Influencer Champion three years in a row.

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