LLC Domestication and Conversion

LLC owners that move to another state often want to move their business with them. While there are several ways to move a business to a new state, LLC domestication is a popular option. Domestication allows the owners to change the governing law of the LLC without disrupting ongoing business operations. This article discusses LLC domestication and compares it to other alternatives.

What is LLC Domestication?

Domestication is a legal process that allows an LLC to change the governing law that applies to the LLC. When the domestication process is complete, the law of the original state no longer governs the LLC. For example, an LLC formed initially as a California LLC under California’s LLC act can domesticate the LLC to Texas. After the domestication, the LLC is governed by Texas law instead of California law.

Reasons for LLC Domestication

LLC domestication changes the law that governs the LLC without changing the form of the business entity. The LLC remains an LLC, but becomes governed by the law of a different state. LLC owners may want to change the LLC’s governing law for three reasons:

• Owner Relocation. When the owners move to a new state, they often want to move the LLC with them. As long as they do not plan to continue to conduct business in the original state, moving the LLC allows the owners to coordinate the law that governs their LLC with the law that governs them, personally. Domestication also keeps the LLC “local” and makes it easier for the owners to find attorneys and other professionals in their state of residence.
• Avoid Multiple Filings. If an LLC is organized in one state and does business in another, the LLC must keep up with two sets of legal requirements, discussed below. If the owner no longer does business in the original state, moving the LLC to the state where it does business eliminates the hassle of multiple filings.
• Dissatisfaction with Original State Law. If the LLC was formed in a state with onerous legal requirements, the owners might want to “get out from under” the law of the original state and into a more business-friendly LLC statute.

Because LLC domestication preserves the LLC’s existence, there is no need to transfer employees, assets, or licenses to a new LLC. This simplicity makes domestication attractive to LLCs with many employees, assets that cannot be easily transferred, entity-specific licenses that cannot be assigned, or tax items to preserve.

Benefits of LLC Domestication

Compared to the alternatives (discussed below), LLC domestication can move the LLC to the new state without sacrificing continuity of the business. LLC domestication has several benefits:

• Business Continuity. LLC domestication avoids disrupting business operations. The domesticated LLC continues to operate in the same way as the original LLC.
• Same Bank Accounts. LLC domestication can avoid the need to open new bank accounts. Although the LLC may want to notify the bank of the change, the LLC can usually continue to use the same bank accounts and operations.
• Same Taxpayer. The LLC continues to be treated the same for tax purposes. It may continue to use its employer identification number and file taxes as it did before the domestication.
• Same Contracts. The LLC may continue its existing relations with its employees, investors, and vendors. There is usually no need to update or assign contracts to a new business entity.

LLC domestication has important legal consequences, but few practical consequences. The seamless transition from one state to another often makes LLC domestication more appealing than other alternatives.

Alternatives to LLC Domestication

LLC domestication is not always necessary just because an owner moves to a new state. Even if the owner plans to operate the LLC from the new state, there are two alternatives to LLC domestication to consider: operating the LLC as an out-of-state LLC and forming a new LLC.

Operating the LLC as an Out-of-State LLC

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.

Forming a New LLC

Depending on the circumstances, forming a new LLC in the new state may be much less complicated than moving the old LLC to the new state. Domesticating an LLC requires all of the steps of new LLC formation—including a new operating agreement and related documents—in addition to the paperwork required to domesticate the LLC. It may be less hassle—and less expensive—to simply start fresh. The LLC owner could form a new LLC in the new state without domesticating the prior LLC.

Whether a new LLC formation is a better choice than LLC domestication 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. The hassle of transferring items over to the new LLC outweighs the hassle of LLC domestication.

On the other hand, LLCs with a relatively simple structure—for example, a single-member LLC that provides services and has no assets other than a bank account—may benefit from a new LLC formation instead of domestication. In this scenario, forming a new LLC may be a simple matter of setting the LLC up in the new state and opening a single bank account in the name of the new LLC.

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.

The 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. Because LLC domestication rarely requires the LLC to be dissolved in the original state, the cost of LLC domestication is often little more than the cost of forming a new LLC and dissolving the old one.

LLC Domestication vs. LLC Conversion

The term domestication deals specifically with moving an entity from one state to another without changing the form of the entity. An LLC that domesticates from Texas to Nevada is still an LLC. The only change is the law that applies to the LLC.

The term conversion has historically applied to changes in the form of entity. A Texas LLC that changes to a Nevada corporation is no longer an LLC. It has converted from one entity type (LLC) to another (corporation). That is true regardless of whether the business moves to a different state. A Texas LLC could also convert to a Texas corporation under the Texas conversion statute, even though Texas law applies to both the old LLC and the new corporation.

Strictly speaking, the term domestication refers to a change in governing law; the term conversion refers to a change in the form of entity. But many state LLC acts have blurred this distinction by using the term conversion to refer to both changes in governing law and changes in the form of entity. In these states, the term conversion could mean either:

• A change in the form of an entity from an in-state (domestic) entity to an out-of-state (foreign) entity; or
• A change in the form of an entity from one entity type to another entity type.

In states with LLC acts that use conversion as a catch-all term, the term domestication does not appear in the statute. But this does not mean that domestication is not allowed, only that the statute uses different terminology.

How to Domesticate an LLC

The LLC domestication process is not uniform. Each state that permits domestication has its own requirements, and the laws of both the original formation state and the law of the new state must be satisfied. Domesticating an LLC generally requires these steps:

1. Draft Plan of Conversion. The LLC attorney must draft a plan of conversion. As the name suggests, a plan of conversion is a plan for the domestication/conversion process. It authorizes the remaining steps required for domestication. Because state LLC acts differ in the information that must be included in the plan of conversion, careful drafting must ensure that the plan meets the requirements of both state LLC acts.
2. Approve the Plan of Conversion. The plan of conversion must be approved by the LLC members as required by the LLC acts of both states. To show approval and formally adopt the plan, each member usually signs the plan of conversion.
3. Draft Documents for Original State. Each state requires a domestication document to carry out the plan of conversion. Depending on state terminology, this document may be called a certificate of conversion or articles of domestication. The original state may also require a certificate of surrender or similar documents to notify the public that the LLC will no longer conduct business in the original state.
4. Draft Documents for New State. As with the original state, a certificate of conversion or articles of domestication must be prepared under the plan of conversion. In addition to the conversion filing, a formation document—often called a certificate of formation or articles of organization—must also be filed with the new state to form the new entity. In some states, the formation document must include details about the prior LLC.
5. File Conversion Documents with Both States. Once the domestication documents are prepared, they must be filed with both states. While there is a trend toward allowing the domestication documents to be filed online, many states require the documents to be manually submitted and reviewed by an examining agent. The LLC attorney may need to communicate with the examining agent about the filing, and post-filing clean-up work is not unusual.
6. Pay Required Fees. Each state has fees that must be paid in connection with the domestication. These fees can vary greatly by state. To move an LLC from Florida to Texas, for example, the Texas filing fees are $600. Florida only charges $25.
7. Draft Remaining Formation Documents for Domesticated LLC. The domestication paperwork only moves the LLC to the new state. To be properly formed, the LLC still needs the remaining documents to provide for its operation and governance (the second step of the two-step LLC formation process discussed here). These documents include a well-drafted operating agreement and an organizational resolution for the new LLC.

Tax Effects of LLC Domestication

Because an LLC domestication is simply a change in governing law, it has no federal tax consequences. The LLC may continue to use the same employer identification number and file its taxes as it always has.

Although there are no federal tax consequences to consider, there may be state-law tax consequences to keep in mind. For example, Texas law requires the franchise taxes to be paid or the new LLC to be responsible for the unpaid franchise taxes. This requirement is satisfied by obtaining a certificate of franchise account status from the Texas Comptroller or—more commonly—to include a statement in the LLC domestication documents that makes the new LLC responsible for any unpaid franchise tax obligations of the old business.