LLC Domestication Alternatives
LLC domestication—known as conversion in some states1—is the most efficient way to move a business from one state to another. It allows the LLC to transfer to a new state without business disruption and without losing its employer identification number (EIN). After the domestication is complete, the LLC is no longer treated as having been organized in the primary state. Instead, the LLC is treated as though it had been formed in the state to which it has been transferred.
LLC domestication must be authorized by statute. To date, 36 U.S. jurisdictions have enacted laws authorizing LLCs to domesticate into the jurisdiction. These laws require—as a condition of the domestication—that the law of the state where the LLC was formed must also allow domestication. State law does not allow an LLC to domesticate into that state unless domestication is also permitted in the state that the LLC is coming from.
These rules require an analysis of the laws of both the state that the LLC is moving from and those of the state that the LLC is moving to. Both must permit domestication for it to be possible. LLC domestication is a relatively new procedure, and not all states permit it. The following states do not have statutory conversion or domestication procedures for LLCs:
|Alabama||Maryland||New Mexico||South Carolina|
In these states, statutory domestication and conversion are unavailable. To move an LLC to or from one of these states, business owners must use other alternatives. These alternatives—each of which is discussed below—include operating the LLC as an out-of-state LLC, forming a new LLC and dissolving the old LLC, and forming a new LLC and merging the old LLC into it.
Forming a New LLC and Merging the Old LLC Into the New LLC
The final alternative is to form a new LLC in the new state and combine the old LLC with the new LLC using a statutory merger. A statutory merger is the closest approximation to a statutory domestication or conversion procedure. It has the following benefits:
- No need to dissolve old LLC. Because the old LLC is viewed as continuing its existence through the merger with the new LLC, there is no need to dissolve (or worry about the administrative dissolution of) the old LLC.
- No need to transfer assets. The merger laws of most states provide that, upon the merger of one LLC into another, the rights, obligations, and assets of the merging LLC continue in the new LLC. There is no need to transfer assets or assign contracts between the two LLCs.
- Retained EIN. The LLC may be able to retain its EIN. Keeping the same EIN avoids other hassles, such as firing and rehiring employees, opening new bank accounts, or losing benefits or accounts tied to the LLC’s EIN.
Whether the LLC can retain its EIN depends on the LLC’s tax classification.
LLC Treated as a Disregarded Entity
If the old LLC is owned by a single-member LLC treated as a disregarded entity (sole proprietorship) that reports income on Schedule C of the owner’s personal income tax return, the owner may continue to use his or her social security number as the EIN for the new LLC (assuming no other owners are added).
LLC Treated as a Partnership
If the old LLC is a multi-member LLC taxed as a partnership, the LLC that results from the merger is considered to be a continuation of the old LLC whose partners own more than 50 percent of the capital and profits interests in the new LLC.2 This 50-percent rule can present challenges when combining partnerships with different owners. When the purpose of the merger is to relocate the LLC to another state, though, the ownership of both LLCs is the same. The 50-percent rule is always satisfied.
Assuming that the old LLC’s partners continue to own the new LLC, the new LLC can be treated as the surviving entity and a continuation of the old LLC. This treatment allows the new LLC to keep the EIN, accounting methods, tax years, and elections of the old LLC. When the new LLC files its next tax return, it states that the new LLC is a continuation of the old LLC.3
LLC Treated as a Corporation
If the old LLC has elected to be taxed as a corporation, it may engage in a tax-free F reorganization under the Internal Revenue Code.4 An F reorganization treats the transaction as a “mere change in identity, form or place of organization” of the LLC (and not as a taxable event). To qualify as an F reorganization:
- All membership interests in the new LLC must be distributed (or deemed to have been distributed) in exchange for membership interests in the new LLC.
- The same persons must own all of the membership interests of the old LLC, as determined immediately before the reorganization, and of the new LLC, immediately after the reorganization, in identical proportions.
- The new LLC may not hold any property or have any tax attributes immediately before the reorganization, other than a de minimis amount of assets as needed under local law to facilitate the incorporation or maintain its legal existence.
- The old LLC must completely liquidate (or be deemed to have liquidated) for federal tax purposes (e.g., by merger), but may retain a de minimis amount of assets to preserve its legal existence, rather than dissolve.
- The new LLC must be the only acquiring entity and, immediately after the reorganization, the new LLC must be the only entity holding property that was held by the old LLC immediately before the reorganization.
- The old LLC must be the only entity acquired by the new LLC immediately after the reorganization and the new LLC may not hold property from a corporation other than the transferor LLC (if it would succeed to the tax attributes of that other corporation under I.R.C. § 381(c)).
If the transaction qualifies as an F reorganization, the new LLC succeeds to the tax attributes of the old LLC and continues to operate as normal. The taxable year of the old LLC does not close. Instead, the new LLC is treated as continuing the taxable year of the old LLC.5
The formation of the new LLC and the merger of the old LLC into the new LLC should not be taxable. The old LLC is treated as transferring its assets to the new LLC in exchange for membership interests in the new LLC and the assumption of the LLC’s liabilities. This deemed transfer should be exempt from tax.6 The old LLC is then deemed to distribute the membership interests of the new LLC to its owners in a tax-free transfer.7 The new LLC is protected from recognizing gain or loss.8 As a result, the EIN and tax attributes of the old LLC should pass to the new LLC.
Operating the LLC as an Out-of-State LLC
If domestication is not available, the owners may choose to continue to operate the LLC in its original state of formation. State LLC acts do not require LLCs to be governed by the laws of the state where the owner resides. Because state law does not require the LLC to follow the owner to a new state, an owner that moves to a new state may continue to operate the LLC as is, without changing the governing law.
Continuing to operate as an out-of-state LLC has appeal, but only if the LLC does not plan to conduct business in the new state. Whether an LLC conducts business in a state is often hard to determine, and there may be no clear answer. But if the LLC will conduct business in the new state, the LLC is legally required to register to do business in the new state. The registration requirement creates two separate sets of laws that govern the LLC:
- The law of the original state, which has its own annual requirements for maintaining the LLC; and
- The law of the new state that apply to out-of-state businesses doing business in-state.
Complying with both sets of laws adds considerable hassle to the LLC’s legal maintenance paperwork and—depending on the filing fees required by each state—can significantly increase the annual cost of maintaining the LLC. Avoiding these dual registration requirements is a primary reason why business owners seek to move the LLC to the new state.
Forming a New LLC and Dissolving the Old LLC
Another option is to form a completely new LLC in the new state and wind down and formally dissolve the existing entity in its current state. This approach is effectively the end of the old LLC.
- Obtain a new EIN. Unless the LLC is a single-member LLC treated as a disregarded entity that reports its income on its owner’s tax return, the LLC will need to obtain a new EIN.
- Open new bank accounts. The LLC must open new bank accounts using its new EIN.
- Dismiss and re-hire employees. The LLC must transfer employees to the new LLC by dismissing them from the previous LLC and re-hiring them through the new LLC.
- Transfer assets. The LLC must sign assignments, deeds, or other transfer documents to move the LLC assets to the new LLC.
- Assign contracts. If the prior LLC is a party to a contract that the new LLC would like to preserve, the owners must negotiate with the other party to get permission to assign the contract to the new LLC.
Whether this approach is a practical alternative depends on the business. If the business has many employees, hard-to-transfer assets, licenses tied to the old business form, or tax items to preserve, forming a new LLC may not be feasible.
When considering whether to form a new LLC instead of domesticating an existing LLC, the owners should also consider the costs of dissolving the old LLC. Risk-tolerant owners may simply transition the assets over to the new LLC, then forget about the old LLC. The Secretary of State or other agency will usually dissolve the abandoned LLC due to failure to meet filing requirements. But this can be a risky plan. Depending on state law, failure to properly dissolve the old LLC can create liability for the owners and result in financial penalties if the owners later need to wind up the LLC.
A better approach is to properly dissolve the old LLC after the new LLC is formed. In this scenario, the costs of dissolving the LLC must be factored into the decision.
Evaluating the Alternatives
If domestication is unavailable, the next-best choice is usually the formation of a new LLC followed by a statutory merger. This method best approximates an LLC domestication in that it provides for an automatic transfer of assets and, in many cases, allows the LLC to retain its EIN.
- Of the 36 states with statutory procedures for changing the jurisdiction of an LLC, 22 use the term domestication and 14 use the term conversion.
- I.R.C. § 708(b)(2)(a).
- Treas. Reg. § 1.708-1(c)(2).
- See I.R.C. § 368(a)(1)(F).
- Rev. Rul. 64-250, 1964-2 C.B. 333 and Rev Rul. 2004-85.
- I.R.C. §§ 361(a) and 357(a).
- I.R.C. § 354.
- I.R.C. § 1032.