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delawareOne of the top questions business owners and startups often ask is whether it makes sense to convert their non-Delaware corporation or LLC into a Delaware C Corporation.  Usually, this arises when venture capital or other funding sources condition receiving funds on making the switch.

Although the term “reincorporation” is frequently used, there is no single step by which a company can “reincorporate” in another state – it usually involves conversion, a reverse merger, a transfer of assets, or a another kind of reorganization.

Conversion allows companies to convert into becoming an entity in the new state. For example, Delaware allows foreign corporations and foreign/Delaware LLCs to convert into a Delaware corporation pursuant to Section 265 of the Delaware General Corporation Law.  It’s a simple step that bypasses the other traditional methods that can be expensive and cumbersome.  However, even with Delaware’s easy conversion law, it can sometimes be complicated to make the change.  Most states require LLCs that want to convert into corporations to have a  conversion plan and have that plan approved by the majority of LLC members.  If there are LLC members that do not agree or have objections to the conversion, problems could arise. For LLC conversions particularly, there are also some tax considerations that should not be ignored. Delaware, for example, does tax members’ LLC interests, so it may make sense to convert into a Delaware C corporation rather than a Delaware LLC, even if starting from a foreign LLC.

Once the conversion is approved by the majority of the foreign LLC or corporation’s members/shareholders, then Certificate of Conversion and Certification of Formations must be filed with the Delaware Secretary of State and the applicable fees paid. The IRS should also be notified of the change of status of the company, through a Form 8832.

If you are converting into a state other than Delaware, you may need to follow traditional methods of reincorporation. These include a reverse merger or an asset transfer. In a reverse merger, you will create a new entity in the new state, and then merge the old corporation into the new one.  Many states have what is called a certificate of merger, which will inform the secretary of state as to which of the two entities will be surviving.  For tax purposes, the new corporation is often able to retain the old corporation’s Tax EIN number and classification. An asset transfer is where a newly formed entity purchases the assets of the former entity.  It may also be necessary for you to dissolve the old corporation, which will include cancelling licenses and permits, distributing final paychecks, submitting final tax returns, notifying creditors, and advising customers.

With reverse mergers and asset transfers, tax consequences can also arise.  For example, a C corporation with appreciated assets that liquidates must pay taxes on any income. Shareholders who receive assets on liquidation also have to pay taxes on any income of the stock has appreciated. S Corporations, on the other hand, are “pass-through” entities, so there may be no immediate taxation to the corporation or shareholders.

If you are ready to convert your corporation into a Delaware entity, here are some links to help you get started. If you end up needing help, don’t hesitate to drop us a line.

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Additional resources

Information about Delaware Franchise Taxes

Calculating Delaware Filing Fees

Getting a Delaware Agent

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