Convert an LLC to a C Corp: Tax Consequences
The three ways to convert, the tax-free incorporation rules, the built-in liabilities trap, and why startups raising capital do it
Reviewed by the Fairlight Accounting cross-border tax team — U.S. & Canadian Tax Desks
An LLC becomes a C corporation by a state-law conversion or merger into a new corporation, or by electing corporate tax classification on Form 8832 while remaining an LLC. Each is generally tax-free under section 351 — the assets are treated as contributed for stock — but liabilities exceeding the members' basis trigger gain, and double taxation replaces pass-through treatment.
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Why convert at all?
Venture capital: institutional investors want a Delaware C corporation with preferred stock, and an LLC's partnership taxation (K-1s, unrelated business income for tax-exempt investors, phantom income) is a barrier to a priced round. Qualified small business stock: section 1202's exclusion of gain — 50, 75, or 100 percent after three, four, or five years for stock acquired after July 4, 2025, up to US$15 million per issuer — is available only for C corporation stock; the holding period starts at conversion, and appreciation before the conversion is not excludable. Stock options: a C corporation can grant incentive stock options; an LLC's equivalents (profits interests) are workable but unfamiliar to employees and investors. Retained earnings: a corporation's flat 21 percent rate on profits it keeps can beat the owners' marginal rates on pass-through income for a business reinvesting heavily. Against these: double taxation of distributed profits, the loss of pass-through losses in the early years, and the complexity of unwinding if the plan changes.
The three methods
| Method | Mechanics | Result |
|---|---|---|
| Statutory conversion | File a certificate of conversion under state law; the LLC becomes a corporation, often keeping its EIN (confirm with the IRS's new-EIN guidance), contracts and assets unchanged | The cleanest path where the state allows it (Delaware and most states do) |
| Merger | Form a new corporation; merge the LLC into it under state law, with members receiving stock | Used where statutory conversion isn't available or a new-state entity is wanted |
| Check-the-box election (Form 8832) | The LLC stays an LLC under state law and elects to be taxed as a corporation (an "association") | Simplest and reversible in form (though generally not again for 60 months) — but the LLC is now a corporation for tax, with all the consequences, and the reversal is a taxable liquidation |
All three are treated for tax as the LLC contributing its assets and liabilities to a corporation in exchange for stock, followed by a distribution of the stock to the members (the "assets-over" form), and all three are governed by section 351.
When is it tax-free?
Section 351 defers gain when property is transferred to a corporation solely in exchange for its stock, and the transferors as a group control the corporation (at least 80 percent of the voting power and of each other class of stock) immediately after. An LLC-to-corporation conversion nearly always satisfies control, because the members receive all the stock. The members take a basis in their stock equal to their basis in the LLC interests (adjusted), and the corporation takes the LLC's basis in the assets — no step-up, no gain. Two exceptions produce gain: liabilities assumed by the corporation that exceed the total basis of the assets transferred (section 357(c) — common where the LLC has borrowed against appreciated or depreciated assets, or has distributed borrowed cash to members), and any cash or other property ("boot") the members receive alongside stock.
What happens to the LLC's tax attributes?
Depreciation schedules continue (the corporation steps into the LLC's basis and methods). Suspended passive or at-risk losses of the members do not transfer to the corporation and are generally released or lost depending on the rules. An LLC's net operating losses belonged to the members, not the entity — they stay with the members. Accounts receivable of a cash-method LLC become the corporation's income when collected (no gain on transfer, but the corporation, not the members, reports the collections). The LLC's tax year ends on the conversion date, with a final partnership return (Form 1065) and K-1s for the short year.
What does the conversion cost later?
Double taxation: the corporation pays 21 percent on its profits, and shareholders pay again on dividends (at qualified dividend rates) — unless section 1202 excludes the gain on an eventual stock sale, which is the bet most venture-backed conversions make. Built-in gains: if the corporation later elects S status, appreciation existing on the first day of the first S corporation year is taxed at the corporate level (21 percent) if recognized within the five-year recognition period. Personal goodwill and the founder's relationships: once transferred to the corporation, they are the corporation's, which affects a later sale (the consulting succession guide).
Should it be an S election instead?
An LLC that wants to reduce self-employment tax, keep pass-through treatment, and has no plans for venture capital or section 1202 elects S corporation status with Form 2553 (the Form 2553 guide) — one class of stock, eligible shareholders, no double tax, and the reasonable-salary arithmetic. The C corporation conversion is for businesses that expect to raise institutional capital, issue preferred stock, reinvest heavily, or position for a section 1202 exit. A business that converts to C for the wrong reason pays two levels of tax for nothing.
Worked example
A two-member software LLC with US$400,000 of assets (basis US$150,000), a US$200,000 bank line the members drew and distributed to themselves, and a term sheet from a venture fund requiring a Delaware C corporation. Statutory conversion in Delaware: the members receive common stock; the fund buys preferred. Section 351 applies — control is satisfied. But liabilities assumed (US$200,000) exceed the basis of assets transferred (US$150,000): US$50,000 of gain is recognized by the members under section 357(c), allocated between them. Had the members contributed US$50,000 of new cash to repay the line before converting, no gain — repaying it from the LLC's own cash would have cut asset basis by the same amount. Post-conversion: the corporation depreciates the assets on the LLC's schedule, the members' stock basis is their LLC basis, the section 1202 holding period starts on the conversion date, and the LLC files a final Form 1065 for the short year. The founders' pass-through losses from the LLC's first two years stay on their personal returns, already used.
Frequently asked questions
Is converting an LLC to a C corporation taxable?
Generally no — section 351 defers gain when the members receive stock and control the corporation. Gain is recognized to the extent liabilities assumed exceed the basis of the assets transferred, or to the extent members receive cash or property other than stock.
Why do startups convert to C corporations?
Venture investors require a C corporation with preferred stock; section 1202's gain exclusion applies only to C corporation stock; incentive stock options require a corporation; and a corporation retaining earnings pays the flat 21 percent rate.
What is a statutory conversion?
A state-law procedure (available in Delaware and most states) by which an LLC becomes a corporation by filing a certificate, keeping its contracts, assets, and usually its EIN, without forming a new entity and merging.
Should I convert to an S corporation instead?
If the goal is reducing self-employment tax while keeping pass-through treatment — and there is no venture capital, preferred stock, or section 1202 plan — an S election on Form 2553 is usually the better and cheaper move.
Official sources
The IRS states: “The Form 8832 is also filed to change the LLC’s entity classification. Thus, an LLC that has been treated as a partnership for several years may be able to prospectively change its classification to be treated as a corporation by filing Form 8832.” — Internal Revenue Service, LLC filing as a corporation or partnership, https://www.irs.gov/businesses/small-businesses-self-employed/llc-filing-as-a-corporation-or-partnership
The IRS states: “Generally, an election specifying an LLC’s classification cannot take effect more than 75 days prior to the date the election is filed, nor can it take effect later than 12 months after the date the election is filed.” — Internal Revenue Service, Limited liability company (LLC), https://www.irs.gov/businesses/small-businesses-self-employed/limited-liability-company-llc
Next step
Fairlight Accounting is a cross-border accounting and tax practice with a U.S. Tax Desk and a Canadian Tax Desk. Our U.S. Tax Desk handles entity conversion planning — section 351 and 357(c) analysis, pre-conversion debt cleanup, final partnership returns, section 1202 positioning, and the S-versus-C decision. See pricing or book a call.
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