It's tax season. You watch a hefty portion of profits flow straight to the IRS. This recurring hit makes you question your company's legal structure. Should your business remain a C corporation? Would converting to an LLC make more financial sense?
This guide breaks down key differences between C corporations and LLCs, explores why businesses convert, outlines the three conversion methods, walks through the process, and helps you understand real costs involved.
What is a C corporation?
A C corporation exists as its own taxpayer. Profits get taxed once at the corporate rate and again when distributed as dividends. This creates the classic double taxation familiar to anyone writing dividend checks. C corps can issue unlimited shares, making it straightforward to swap equity for outside capital. Many venture funds insist on this structure because it fits their investment models.
This structure comes with administrative overhead that can slow you down. Corporate law requires boards, formal meetings, and detailed minutes—tasks that keep lawyers busy and pull your focus away from actually building the business.
What makes an LLC different?
LLCs offer pass-through taxation. Income flows directly to owners, appearing once on personal returns. Same revenue, one fewer tax bill. LLC interests bring flexibility internally but greater difficulty when transferring to institutional investors. They fit best when funding growth from operations rather than outside capital.
LLCs cut most red tape, giving you operational flexibility without the formalities. You can manage collectively or appoint a single manager, skipping the annual parade of resolutions entirely. As you prepare for this transition, understanding what financial statements you'll need to maintain for your LLC helps you plan ahead.
Neither entity stands inherently better. The right fit depends on your business .
Why businesses convert to LLCs
Running a profitable company can change the math that once made a C corporation attractive. When cash flow matters more than term sheets, an LLC often offers a cleaner path. Here’s why companies often convert:
The tax math changes
C corps pay tax on earnings. Then shareholders pay tax again when those earnings leave the company. LLCs eliminate this second layer through pass-through taxation. Income appears once on personal returns, often lowering the combined bill. For many owners, eliminating double taxation becomes the biggest incentive to switch.
Operational simplicity
LLCs replace board meetings, formal minutes, and shareholder votes with an operating agreement owners control. That flexibility allows adjusting profit splits or decision-making authority without drafting corporate resolutions. The lighter administrative load saves legal fees and mental bandwidth.
When fundraising plans change
If venture capital remains on the roadmap, a C corp usually stays the default. But once growth becomes self-funded, an LLC's flexibility can outweigh its fundraising limitations. This provides control over cash distributions and ownership shifts without preferred stock waterfalls.
The move doesn't suit everyone. Businesses eyeing institutional capital or an imminent sale might stick with a corporation. Yet for companies prioritizing profitability and simple governance, an LLC aligns legal structure with operational reality.
The 3 method to convert to an LLC
Now that you've decided if an LLC is right for you, here’s how you actually make the change. Each of these three methods brings you to the same destination LLC with pass-through taxation, but the paperwork load and timeline vary considerably.
Method 1: Statutory conversion
Roughly 30 states let you file a certificate of conversion that transforms your corporation directly into an LLC. Your entity continues with the same EIN, contracts, and permits intact. You won't need to retitle assets or update every bank account. State approval typically takes two to four weeks.
The tax treatment varies by method. Non-statutory conversions typically trigger complete liquidation and recognition of built-in gains. Statutory conversions may qualify as nontaxable under IRC Section 351 and defer gain recognition.
Method 2: Statutory merger
When direct conversion isn't available, many states allow statutory mergers. You form a new LLC first, then merge the corporation into it. The merger agreement specifies how shares convert to membership interests. Once approved, the corporation disappears and the LLC inherits all assets and liabilities.
Expect four to eight weeks for the process, plus time to update licenses and apply for a new EIN. The tax implications mirror those of statutory conversion.
Method 3: Non-statutory conversion
In states without conversion or merger options, you must manually transfer each asset from the corporation to a new LLC, then dissolve the original entity. Every deed, contract, and permit needs individual reassignment, often requiring third-party consent. This complexity stretches timelines to several months while legal fees climb with each additional document. The risk of overlooking something critical grows alongside the paperwork.
Tax treatment follows the same liquidation rules, but administrative complexity makes this the least attractive option. Where statutory conversion is available, it's usually the most efficient choice.
Step-by-step conversion process
Regardless of the method, converting a corporation requires a coordinated project with legal, tax, and operational checkpoints.
Step 1: Assemble your professional team
Find a tax attorney or CPA who has navigated entity changes. Add a corporate attorney in your state. Include your existing bookkeeper. If you need help with the filing process, online incorporation services can streamline the paperwork. The tax hit alone can dwarf professional fees, so expert modeling proves money well-spent.
Step 2: Run a detailed tax analysis
With advisors in place, pinpoint appreciated assets that could trigger gain recognition, evaluate accumulated earnings, and map state-level quirks. Know the real tax bill before you file anything. The IRS treats most corporation-to-LLC conversions as corporate liquidations, but exceptions exist depending on specific circumstances.
Step 3: File paperwork with the state and IRS
Your attorney will file a certificate of conversion or merger plus new articles of organization. Federally, you close the corporation with a final Form 1120 and submit Form 966 to record the liquidation. The new LLC files as a partnership or disregarded entity going forward. Many states approve conversions within four to eight weeks.
Step 4: Retitle assets and update accounts
Once the state signs off, update everything that touches money or ownership. Real-estate deeds, vehicle titles, and IP registrations need updating. Bank accounts require attention. Relay lets you keep the same multi-account setup by simply updating the name on file.
Relay is a financial technology company and is not an FDIC-insured bank. Banking services provided by Thread Bank, Member FDIC. FDIC deposit insurance covers the failure of an insured bank. Certain conditions must be satisfied for pass-through deposit insurance coverage to apply.
Step 5: Wind down the corporation
Complete the final administrative tasks by filing payroll and sales-tax returns, settling outstanding liabilities, and notifying creditors if your state requires it. Close the old EIN once everything is resolved. Even with a smooth statutory conversion, expect two to six months from start to fully operational LLC.
Real costs and complications to expect
Run the numbers before you move ahead. Regardless of which conversion method you choose, the IRS treats converting a corporation to an LLC as a full liquidation. You effectively sell the company to yourself.
First comes the tax hit. The corporation recognizes gain on any appreciated assets. Then shareholders might recognize gain again when those assets transfer through deemed distribution. This two-step recognition often catches business owners off guard. State taxes typically mirror federal treatment, stacking another layer of cost on top.
Next, consider what you could lose. Net operating losses rarely survive liquidation. Certain tax credits often disappear once the corporation dissolves. If future fundraising might appear on your roadmap, many VCs won't invest in an LLC. This could limit your options down the line.
Then comes administrative reality. Every real-estate deed, vehicle title, and vendor contract might need retitling or third-party consent. Lender covenants can trigger technical defaults. Employee benefit plans may require rewriting. Business licenses often need reissuing. Each requirement adds time and potential complications. Understanding how rising expenses quietly squeeze margins helps you plan for these additional costs.
You'll need professional support to navigate this complexity. Legal, tax, and valuation fees can climb quickly. Five-figure invoices can be common for businesses with multi-state footprints. This precedes the actual conversion taxes, which often exceed professional fees.
Keep cash flow clarity regardless of entity type
The shift from double taxation to pass-through treatment could make a meaningful difference when profits flow directly to owners. The question becomes whether those benefits justify what the IRS treats as a full liquidation.
Running the numbers with your CPA gives you the clearest picture. A modeled tax bill today beats discovering surprises later. Map the timeline against your plans too. If a fund-raise or sale might occur on the horizon, pausing could make sense.
But don’t forget the operational upside—fewer formalities, flexible profit splits, and direct control. Whether you stay a corporation or switch, keeping clear visibility into cash flow helps you turn whichever structure you choose into real advantage. Relay's multiple-account setup makes that simple, regardless of your entity type.
Relay is a financial technology company and is not an FDIC-insured bank. Banking services provided by Thread Bank, Member FDIC. FDIC deposit insurance covers the failure of an insured bank. Certain conditions must be satisfied for pass-through deposit insurance coverage to apply.
