Want to Change Your Business Legal Type? Here's How
Changing from One Type to Another, With a Checklist
Want to change your business type? It's easier than you might think. In this article, we'll look at why businesses might decide to change, and how to make the change, depending on which type of business you are moving from and moving to.
Most of the time, a business will change from less complex structure to more complex structure, but there may be times when a more complex organization, like a corporation, for example, may decide to become less complex.
Why Change Your Business Type
As a business grows, things change. Here are some reasons a business might decide to make a change:
Liability protection. Many small businesses begin as sole proprietors and decide at some point to lessen their personal liability by forming a business entity which can offer some liability protection, such as an LLC or a corporation.
Tax considerations. Most often, businesses change legal type for tax reasons. The most common change for this reason is from a pass-through entity to a corporation. A pass-through entity is a business that pays taxes through the personal tax returns of its owners. These entities - sole proprietorship, partnership, and LLC - must pay taxes on the total net income of the business each year. A corporation may retain some of its income (keep it in the business), which lowers the business tax bill.
If your business starts out not making much profit, you may want to consider a change
Employees. Having employees changes your business liability and complexity, and you might want to consider going to a business type that provides you with more protection against lawsuits.
Going public. A small business might decide to finance expansion by going public; that is, selling shares to the public. Going public usually requires that the business become a corporation.
Change in ownership. Adding owners, or having owners leave, may suggest a change in business structure.
Using an Attorney to Help Change Business Structure
In most of the changes described below, it's a good idea to get an attorney involved in the process, to make sure you are not missing any important details or tax or legal implications of the change. In most cases, both tax and legal issues are in play, so you may want to get the advice of a tax professional as well as an attorney.
Changing from a Sole Proprietorship
A sole proprietor business is considered the default business organization form. If your business isn't registered as something else in your state, you are a sole proprietor. A sole proprietor business is the easiest to form; no state business registration is required and no formal documents are needed. It's easy to change from a sole proprietorship to a different legal form.
- Sole proprietorship to Limited Liability Company (LLC) or partnership. The business must register as an LLC or partnership with the state in which it is doing business. Then the owners must create appropriate documents to run the business - an operating agreement for an LLC or a partnership agreement for a partnership.
- Sole proprietorship to Corporation. The process to change a sole proprietorship to a corporation is similar to the change to an LLC or partnership - filing registration documents with the state in which you are doing business. In the case of a corporation, you must also designate shareholders and officers, create corporate by-laws, and other tasks in the process of creating a corporation.
- Sole proprietorship to S Corporation. The change of any business entity to an S corporation requires first the formation of a corporation, then a request to the IRS to elect S corporation status. So a sole proprietorship wishing to become an S corporation would first go through the process of incorporation, then electing S corporation status at the appropriate time.
Changing from LLC/Partnership to Corporation/S corporation
Several options are possible for changing an LLC or partnership to a corporation.
- If the reason for the change is primarily taxes, the LLC may request to be taxed as a corporation, leaving the LLC structure in place. There is also a way for an LLC to be taxed as an S corporation.
- The LLC may be dissolved and a separate corporation formed.
- The LLC may become a subsidiary to the newly formed corporation.
- There may be other possibilities, involving the ownership interests of the former LLC members/partners.
This change is one which should be done with the advice of both a tax advisor and legal advisor.
Business Type Change and Your Business Name
In some cases, changing your business legal structure will require a change in your business name. For example, most states require an LLC to include specific terms, like "LLC," in the name of the business. If you change an LLC to a corporation you will have to change the name to remove the LLC designation and add a corporate designation (Inc., for example).
A change in business name will also require notifications to federal, state, and local licensing and taxing authorities. This article describes the process of changing your business name.
A Checklist for Changing Your Business Type
In addition to changing the business legal form, other notifications and registrations are needed.
- A new Employer ID Number (EIN) (tax ID for businesses) will probably be required. You will need to cancel the previous EIN and request a new one from the IRS.
- You will probably need a new Fictitious Name (DBA) statement, which you can get from your county.
- You will need to change the business information with your state taxing authority (for sales taxes, for example) and other state agencies.
- City and county taxing authorities, and licensing and permit agencies will need to be notified.
- And of course you will need to notify everyone with whom you do business, including vendors, advisors, and customers.