Changing Your Entity Choice
As businesses expand or contract, their legal structure may also undergo changes. For instance, you may have started your business life as a sole proprietor but now face a change because you are taking in new owners or want to obtain personal liability protection. What are the legal and tax ramifications of switching entities?
Legal steps
Some changes in entity choice require legal action; others do not.
Legal action required:
- If you want to incorporate a previously unincorporated business, you must set up the corporation in accordance with state law.
- If you want to form a limited liability company, you must create it in accordance with state law.
Legal action is not required:
- If you have been a partnership that becomes a sole proprietorship, no formal action is required if you operate under your own name, but a "DBA" ("doing business as") filing is needed for a fictitious name of the sole proprietorship (e.g., Sally Smith, DBA the Sunshine Flower Shop). This form is filed with your county or city; you can do this yourself and don't need a lawyer for this action; in some locations, state filing is required.
- If you have been a sole proprietorship and want to form a general partnership, no formal legal action is required. Again, you may need to file a form with your county or city for the new fictitious business name of the partnership or do some action at the state level. And you probably want to create a partnership agreement; make sure you have an attorney review your agreement before anyone signs it.
- If you are a C corporation that elects S corporation status, this is a tax election and not a legal action.
Tax issues
Adopting a new entity type may entail a tax cost for the change. For example, if you are a C corporation that elects S status, any appreciated assets carry the potential for a built-in gains tax. This results not at the time of the election but when you dispose of these assets within 10 years of the conversion (a seven-year period applied to dispositions in 2009 and 2010). If you are a corporation that wants to become any other type of entity (e.g., a C corporation that changes to an LLC), the liquidation of the corporation may result in taxation to the corporation and/or shareholders.
When you change your entity choice, you'll also have to change the type of returns you file and learn about other tax-related matters (filing deadlines, filing extensions, etc.). And you may need a new tax identification number (explained later).
Advice: Work with a knowledgeable tax professional before making any change.
New tax ID number
When you make a change in entity, you may need a new employer identification number (EIN), which you can obtain online from the IRS.
You need a new EIN if:
- A sole proprietorship, limited liability company, or partnership incorporates.
- A partnership is taken over by one partner who then operates as a sole proprietor.
- A corporation changes to a sole proprietorship, limited liability company or partnership.
You don't need a new EIN if:
- A C corporation elects to be an S corporation.
- A limited liability company chooses to be taxed as a C or S corporation.
- A partnership converts to a limited liability company classified as a partnership.
Barbara Weltman, author of several books including her most recent, 1001 Deductions & Tax Breaks 2009
www.barbaraweltman.com
Copyright 2010 Author retains ownership. All Rights Reserved.
