Sybil LLC, Inc.

Anyone who watched TV in the 1970s most likely associates the name “Sybil” with the idea of multiple personalities. There are “Sybils” in the business world as well. Generally, limited liability companies with two or more members are treated under Federal tax law as partnerships; LLCs with one member are “disregarded” for Federal income tax purposes, and the income is reported on the sole member’s tax return.

However, an LLC can elect to be treated as a corporation. This election is easily accomplished by filing IRS form 8832 (Entity Classification Election). This choice is especially popular in California, because LLCs that elect to be taxed as corporations avoid California’s LLC gross receipts fee.

Small business owners (and CPAs advising them) may think that, by making this election, they’re getting the best of both worlds: the tax benefits of incorporation, without the corporate formalities—including the necessity of keeping corporate minutes.

But just as it’s not healthy for a person to have multiple personalities, it’s not a good idea for an LLC to elect to be taxed like a corporation.

One reason for this is that, even though the IRS allows an election, it may still require corporate formalities and extensive documentation for aggressive tax deductions. Although a corporation would normally posses this kind of documentation (such as minutes of annual and special meetings and resolutions), an LLC likely will not, since state law does not generally require these kinds of formalities for LLCs. However, as a federal agency, the IRS is not bound by state law. It’s possible, then, that an LLC that elects to be taxed as a corporation may face difficulties in an IRS audit if it can’t produce resolutions and minutes.

The other, potentially more significant, issue is that courts have not yet addressed the liability ramifications of an LLC’s election to be taxed as a corporation. Although it might be assumed that an LLC that elects to be taxed as a corporation will be treated as a corporation only for tax purposes, no LLC wants to be a defendant in the first alter-ego “test case” involving this issue.

Now that you’ve read this far, we’re sure that you’ll recommend that all of your new clients that want to be taxed as corporations form corporations, rather than LLCs. But what’s the “cure” for a new client that already formed an LLC, but really wants to be taxed as a corporation?

The answer is to convert the LLC to a corporation. Although it’s not quite as simple as checking a box on Form 8832, the procedure is still relatively painless, and involves these three basic steps:

1. Draft a Plan of Conversion that summarizes the details of the conversion (including providing for the assignments by which the members of the LLC convert their membership interests for shares of stock);

2. Draft Articles of Conversion and file them with the Secretary of State;

3. Draft and execute bylaws, organizational minutes, share certificates, etc. (i.e., all corporate organizational documents). This ensures that, if the company is faced with an audit or alter ego claim, there is a proper set of corporate documents.