In the life of a business, circumstances may arise that render it necessary or desirable to change the entity’s form (e.g. partnership, LLC, corporation, etc.). Perhaps the company has grown to the extent that access to public capital markets would be beneficial, so a corporate structure is preferable; or maybe general partners want to protect themselves from liability and wish to bring in new investors, so an LLC or LLP appears more suitable. The way the company is treated for tax purposes is also a major consideration. Switching from one entity or association form to another is called conversion, and Pennsylvania’s Entity Transactions Law makes this process relatively straightforward.[1]

Prior to the enactment of the law, conversions could usually only be completed through the creation of and subsequent merger with another entity.[2] These mergers can still be done, though they are messier and require potentially more filings and accompanying fees. The Pa. conversion law allows an entity to convert either by filing a Plan of Conversion or by completing and filing a Statement of Conversion (Form DSCB: 15-355) with the Pa. Department of State. Conversion under this statute also relieves the company owners of the responsibility of winding up and dissolving the converting business.

Throughout the remainder of this article, and for the purpose of providing examples, I will refer to a fictional company called Kings Exteriors, which I invented in an earlier blog post.

Statement of Conversion & Form DSCB: 15-355

The form consists of three pages, though it requires a few additional
attachments including:

• a completed Docketing Statement-Changes Form DSCB: 15-134B
• necessary government approvals
• a copy of the public organic record, i.e. articles of incorporation or certificates of organization
• various other documents, depending on the type of association involved (see page 6 of the form)
• the form itself requires the converting and converted entities’ names, jurisdictions of formation, and entity types

Plan of Conversion

The plan must contain substantially the same information as the statement of conversion. It should include the names of the converted and converting associations, their jurisdiction and type, and the treatment of interests in the associations.

Effects of Conversion

What Happens to the Business EIN?

Depending on the type of conversion you make, you will need to obtain a new Employer Identification Number from the Internal Revenue Service. But typically, changing the name of the business does not trigger the need for a new EIN (though you will need to notify the Pa. Department of State).[3]

For example, if Kings Exteriors converts from a corporation to a partnership, it will need a new EIN. However, converting from a C Corporation to an S Corporation will probably not trigger the need for a new number.[4] For more specific information about other conversions or circumstances, visit the IRS guide.

What Happens to Business Contracts?

Contracts generally remain unaffected after a conversion takes place.[5] In other words, parties to the contracts should continue to fulfill their contractual obligations as if nothing had changed. However, there is an exception where the contract contains a provision that conversion constitutes breach. In that case, the converted entity is still a party to the contract, but will be in breach and will suffer whatever consequences are stipulated in the contract.

For example: Assume that Kings Exteriors is a general partnership and is leasing an office space from Offices, Inc. The lease contract has a provision stating that in the event either party converts to another type of entity, that party will have breached the contract. If Kings Exteriors files Form DSCB: 15-355 to become an LLC, it is in default, but nevertheless, must still continue to abide by the contract’s other provisions. The reverse is also true if Offices, Inc. converts to an LLC or other entity.

How are Business Taxes Affected?

The converting association will likely be taxed differently, though, as mentioned above, companies unsurprisingly prefer to convert in order to receive favorable tax treatment.

Example 1: Imagine that Kings Exteriors is an S Corporation, but its owners want to convert to an LLC. In order to avoid potential negative tax consequences — meaning the owners incur tax liability — the newly converted LLC may elect to be taxed as an S Corporation under IRS Form 2553. In other words, the newly formed LLC is still taxed the way it was before conversion. This election also avoids the formation of a short taxable year where the company could be taxed as a C Corporation.[6] Be aware that even though Kings Exteriors is now an LLC, it must continue to meet the special requirements of an S Corporation in order to be taxed as one.

Example 2: Now imagine Kings Exteriors is a general partnership, but the owners decide they want access to securities markets and also increased protection from liability — so they convert the partnership into a C Corporation. Aside from the numerous document filings required by the Securities Exchange Commission, there willbe tax consequences that the company needs to know about, even if the initial conversion qualifies under the Internal Revenue Code for nonrecognition.[7] Note also that the company will be required to obtain a new EIN.

In Conclusion

Be aware that conversion results in other consequences not addressed in this article. Many of the concerns will relate to potential taxes or securities regulations, which require a careful investigation into those laws and how they relate to converted entities. Additional forms and filings likely will need to be provided to the IRS and the Pa. DOS, depending upon the types of entities involved. Nevertheless, Pennsylvania’s conversion statute provides business owners a more simplified approach to a relatively complex process.

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[1]          See15 Pa. C.S. § 351, et seq.

[2]          https://www.metzlewis.com/new-pennsylvania-entity-transactions-law-permits-statutory-conversion-of-entities/.

[3]          https://www.dos.pa.gov/BusinessCharities/Business/Resources/Pages/Fictitious-Names.aspx.

[4]          https://www.irs.gov/businesses/small-businesses-self-employed/do-you-need-a-new-ein.

[5]          15 Pa. C.S. § 356, Committee Comments

[6]          Bittker, Emory & Streng, “Introduction to S Corporation Eligibility and Treatment,” Thomson Reuters Tax and Accounting, 2, (October 2018).

[7]          http://www.wolverine-startuplaw.com/2018/04/13/tax-consequences-of-converting-from-an-llc-to-a-c-corp/;see also26 U.S.C. § 351.