How to Legally Change the Structure of Your Growing Small Business
by Caron_Beesley, Community Moderator
- Created: December 14, 2011, 6:39 am
- Updated: April 30, 2012, 6:59 pm
Thinking of changing your business structure?
There are many reasons why small businesses change the way their business is legally structured –gaining protection against personal liability, seeking a break from excessive bookkeeping, dissolving a partnership, and more. What are your options and what steps should you follow as you change your business structure?
Changing from a Sole Proprietor to an LLC
Sole proprietorships are one of the most common business structures among small business owners in the U.S. Sole proprietors, however, are vulnerable to personal liability for all business debts and obligations. You may not think that you need protection against liability, but what if a client holds you in breach of contract? Can you afford to put your personal assets at risk to satisfy any claims against your business?
A popular incorporation option for sole proprietors is to become a Limited Liability Company (LLC). An LLC offers protection for the owners' personal assets in the event of lawsuit or debt. It also brings with it tax efficiencies.
How to Change: To change from a sole proprietorship to an LLC, you’ll need to file articles of incorporation and other paperwork with your state government office. This can be done through an online service such as LegalZoom, MyCorporation, or The Company Corporation, or with the help of a lawyer. This guide offers information on how to form an LLC.
Changing from an LLC to a Corporation
If you are considering growing your business and seeking outside investment, you should consider structuring your business as a C Corporation before you start looking for venture capital funding, since converting to a C after involving other people in your LLC ownership will get messy and expensive. The conversion from an LLC to a C Corporation is a relatively standard process and involves some legal expense as you create a new entity and sell the assets of your LLC to the C Corporation in exchange for stock.
Talk to a lawyer or tax expert about the tax implications of this change because you’ll want to make sure the transaction meets the IRS’ conditions for being tax free.
How to Change: As with most business structures, the steps involved depend on the laws in the state where your LLC is registered. Most conversions involve making the LLC a subsidiary of the new C Corporation. A lawyer or online legal service can help with this process.
Dissolving a Business Partnership
Dissolving a business partnership can get messy unless it’s done right. Consider having a buy-sell or buyout agreement in place that plans for succession in the event one partner dies, exits or retires. An agreement on paper can help guide you through the dissolution process (who gets what, etc.) but you’ll also need to follow a series of legal steps.
How to Change: Dissolution of business partnerships is governed by state law, so check your state’s website for information about business partnership dissolution and the forms you need to complete. It’s worth hiring a lawyer and even an appraiser to value your business (partners usually assume assets and liabilities based on percentage of ownership). Your partnership dissolution agreement should outline the terms of the split, much like a divorce decree. Don’t forget to review all leases, licenses, loan agreements, etc. to ensure all partnership commitments are covered and that the appropriate authorities are aware of the change in ownership/dissolution. Once the partnership is dissolved, you may consider forming an LLC or C Corporation.
Changing from a C Corporation to an S Corporation
If you find that being a C Corporation is too cumbersome and expensive for your needs, you may want to consider forming an S Corporation. What differentiates an S-Corporation from a traditional C Corporation is the ability to have profits and losses pass through to the shareholder's personal tax return. With an S Corporation, the business is not taxed itself – only the shareholders are taxed, which can lower a business owner’s taxes. This change can be done with a simple tax form.
How to Change: File IRS Form 2553 Election by a Small Business Corporation (PDF) with the IRS no later than two months and 15 days past the beginning of the tax year for which you made the S corporation election. The IRS restricts eligibility to become an S Corporation. Read about the restrictions on IRS.gov here.
Changing a Business Structure Checklist
Regardless of your current or future structure, these steps should be followed as you change your structure:
- Register with State and Local Agencies - This is where you’ll file articles of incorporation or notify them of a new “Doing Business As” name.
- Register with the IRS – You’ll need to apply for a new Employer Identification Number (EIN).
- Reapply for Business Licenses – They may be required by some states if your structure changes.
- Communicate the Change - Notify banks, insurance companies, customers, vendors, and employees.
- Should You Incorporate Your Freelance or Consulting Business?
- Should My Company be an LLC, an S Corp, or Both?
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