4 Steps to Changing Your Business Structure
by: Rhette Baughman
Assess Your Options; Types of Business Structures
Your business structure determines the amount of regulatory paperwork you have to file, your personal liability for business decisions, how you are taxed on your business income. Sole proprietorships, partnerships, limited liability companies, and corporations are examples of popular business structures. It is important have an understanding of each before you make the decision to change your current structure. For a quick background, review these popular business types:
- Sole Proprietorship - A business owned and managed by one individual who is personally liable for all business debts and obligations.
- Partnership – A single business owned by two or more people.
- Limited Liability Company (LLC) – A hybrid legal structure that provides the limited liability features of a corporation and the tax efficiencies and operational flexibility of a partnership.
- Corporation- An independent legal entity owned by shareholders. A C-corporation is a traditional corporation. A Subchapter S-corporation is a special type of corporation created through a tax election with the IRS. Learn more about S-corporations at Business.gov.
Read about the most common business structures in the Business Incorporation Guide.
Weigh the Pros and Cons- Factors to Consider
Businesses typically change their legal structure because of a change in business need – whether that means accommodating recent growth, reassessing personal liability, or other reasons. Sole proprietorships and partnerships enjoy simple management and operations. LLCs and corporations enjoy limited liability to their personal assets.
If you considering a switch, first reassess the pros and cons of your current business structure and weigh the importance of the following five characteristics to your business: liability, taxation, fees, investment needs, and operational continuity.
- Taxation Alternatively, when you form a corporation, you create a separate tax-paying entity. In some cases, corporations are taxed twice – first, when the company makes a profit, and again when dividends are paid to shareholders on their personal tax returns. Note: LLCs filing as S-corporations can avoid double taxation. They are taxed as partnerships and but also have limited liability.Visit the Business Income Tax Guide at Business.gov to learn more about your busines’s income tax requirements.
- Fees and Forms articles of incorporation, elect officers, and keep additional records.
- Investment Needs – Will investors be involved in your business? A corporation structure allows you to offer stocks, which attracts more investors. Learn more about how to attract investors as Business.gov.
- Operational Continuity – How will your business run 10, 20, or 30 years down the road? Sole proprietorships and partnerships may automatically end or encounter legal problems if the owner dies or retires. On the other hand, corporations and LLCs can continue to operate under new ownership. Learn more about transferring business ownership in our blog.
Know What to Expect – Changes in Business Operations
Here are some changes you should expect when changing your business structure.
- From Sole Proprietorship or Partnership to LLC or Corporation – You (and your partner if it is a partnership) make the decision to change your business structure. Your business will change from unlimited personal liability to limited. Expect to file more paperwork, including your articles of incorporation and bylaws. Fees and expenses will also increase.
- From an LLC or Corporation to Sole Proprietorship or Partnership – Changing from an LLC or corporation to a sole proprietorship or partnership is more difficult, but not impossible. If you own a corporation, you must first convince shareholders to get on board with the plan and liquidate your business assets. As an LLC, you only will see changes in your tax obligations if you file as a corporation. You will need to adhere to specific state policies like licensing requirements and inform the IRS to the change, as your filing requirements will change.
Do It – Steps to Changing Your Business Structures
If you decide that changing your business structure is the way to go, make sure you follow these legal steps to guarantee a successful and smooth transition.
- Register with Local and State Agencies. To convert to a sole proprietorship or partnership, file a DBA or ‘fictitious name’ registration form with your government agency if you plan to operate under a name other than the owners’ legal name. To convert to an LLC or corporation, you must file the articles of incorporation and other paperwork with your state government office.
- Register with the IRS. You will most likely need to apply for a new Employer Identification Number (EIN). If you convert to a corporation, you must file for a new EIN, unless you elect to file as an S-Corporation. Corporations converting to sole proprietorships or partnerships also must apply for a new EIN. Use this checklist from IRS.gov to determine if you need a new EIN. You can learn more about EINs at Business.gov.
- Reapply for Licenses. Some states require you to reapply for licenses when your business structure changes. For example, Minnesota requires plumbing contractors to reapply. Find out about your state’s licensing requirements at Business.gov.
- Spread the Word. Notify your bank and insurance company of the change. Your bank may require you to transfer assets. Also, make sure you inform everyone you do business with, including suppliers, customers and employees, if the change affects them in any way.
Where Can I Find More Help?
Changing your business structure can have significant impact on your business, or it can be a seamless transition if you are well prepared. Remember to consult a professional before you make your decision. Attorneys and accountants have the expertise to advise you on your choice of structure and the full legal and financial implications of the change. Learn more about how to find a small business lawyer and select a small business accountant.
Here are some other resources that can guide you through the process:
- Differences in Legal Structures - Which Structure is Right for You?
- Changing EIN and Your Business Structure at IRS.gov
- Local Compliance Contacts and Resources – a list of point of contacts by compliance categories
- State Business Compliance Contacts and Resources – a list of compliance contacts by state
- Federal Compliance Contacts and Resources – a list of compliance contacts by federal agency
Originally posted at SBA.gov. Written by Christine L., Former Moderator.