Founders often start as an LLC and later raise from investors who expect a Delaware C corporation. Converting is routine, but it touches corporate law, federal tax, state tax, the cap table and the books at once. Done in the right order, it closes cleanly before the round.
Three methods
| Method | How it works | Notes |
|---|---|---|
| Statutory conversion | The LLC converts directly into a Delaware corporation under Delaware law (and the law of its formation state, if not Delaware) | Same legal entity continues; simplest if both states allow it |
| Statutory merger | A new Delaware corporation is formed and the LLC merges into it | Useful when a direct conversion is not available |
| Contribution | Members contribute their LLC interests (or the LLC contributes its assets) to a new corporation for stock | More paperwork; assets and contracts may need assignment |
How the IRS views it
For an LLC taxed as a partnership, Revenue Ruling 2004-59 treats a formless state-law conversion as if the partnership contributed its assets and liabilities to the corporation for stock under Section 351, then distributed the stock to its partners. A single-member LLC disregarded for tax is treated as the owner contributing the assets. In most cases the conversion is tax-free, but watch for:
- Liabilities exceeding the tax basis of assets contributed
- Built-in gains and losses carried into the corporation
- The final partnership return (Form 1065) and K-1s for the short year
QSBS after conversion
Stock received in the conversion can qualify as QSBS if the corporation meets the requirements. Two rules matter:
- The holding period for Section 1202 starts at conversion, not at the LLC's formation.
- Gain built up before conversion is not eligible for the exclusion; the stock's Section 1202 basis is generally the fair market value of what was contributed.
Converting early, while the company's value is low, preserves more of the potential exclusion.
A sequence that works
- Model tax effects and choose the method with counsel.
- Value the business at conversion; document it.
- Approve the conversion under the LLC operating agreement.
- File the certificate of conversion and certificate of incorporation in Delaware.
- Adopt bylaws, elect directors and issue stock per the conversion plan.
- Founders file 83(b) elections within 30 days for any restricted stock.
- Adopt the equity incentive plan; obtain a 409A valuation before granting options.
- Update the IRS (EIN and entity status as required), state tax accounts, payroll, banks and contracts.
- File the final Form 1065 and K-1s for the LLC period, if a partnership.
The books
Close the LLC's books at the conversion date. Members' capital accounts become common stock and additional paid-in capital. Corporate income tax accounting, including deferred taxes, starts from that date.
We coordinate the conversion with your counsel, close the LLC's books, file its final returns and open the corporation's books and tax accounts.
Sources
- Delaware Code, Title 8, Chapter 1, Subchapter XV (conversion and domestication)
- IRS, Rev. Rul. 2004-59, Internal Revenue Bulletin 2004-24 (PDF)
- 26 U.S.C. §351, Transfer to corporation controlled by transferor (Cornell LII)
- 26 U.S.C. §1202 (Cornell LII)
- IRS, About Form 8832
Questions founders ask
Is converting an LLC to a corporation taxable?
Usually not, if structured to qualify under Section 351, but liabilities in excess of basis and other details can create tax. Model it with a tax adviser before signing.
Does the company keep its contracts and bank accounts?
Under a statutory conversion, the entity generally continues as the same legal person, so contracts and accounts carry over. Other methods may require assignments and updates.
