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Is it time to convert your sole proprietorship to a corporation or LLC?

Ann MacDonald - Dec 2007

One of the biggest issues a small business owner must face is whether to incorporate, and if so, when. The question is: Why it so important to form a corporation or LLC? And how do you know which legal entity is the right type for your business?

Many people start their businesses as sole proprietors. Often, it is because they aren't really planning their business and just started selling a product or service. Sometimes, they don't want to go to the effort or cost of incorporating until they know if the business is viable. Other times, they don't feel their business is risky enough to need protection.

Imagine you write software and distribute it as shareware—you might think that is as low risk as it gets, right? However, imagine that you inadvertently distribute a virus that destroys data on people's hard drives. Now you may be liable for their lost data. Selling homemade jam at a farmer's market? Seems harmless enough until someone gets food poisoning and blames your preserves. It is important to learn how to protect yourself from the risks faced by your business.

So What Is a Sole Proprietorship?

In a sole proprietorship, the owner of the business and the business are a single entity. Only one person owns the company and instead of paying corporate taxes, the owner pays personal income tax on any profit. This type of business has some advantages because there is less paperwork—for example simpler tax returns—and there are fewer regulations. Make a profit? It is all yours. On the other hand, if there are problems such as lawsuits? Those are all yours, too.

What Is a Corporation? What Is an LLC?

A corporation makes your business a distinct entity. In other words, it separates your business assets from your personal assets. Worried because you are the only person in your company? That is just fine; one person or multiple people can own a corporation. In most cases, if you are considering incorporating your small business, you will want to investigate S corporations. These are corporations especially designed for small businesses. S corporations are not usually required to pay corporate taxes; instead they only pay taxes on dividend earnings. Growing fast? Want to issue stock? A C corporation will allow you to issue stock and set up a board of directors, but you will have to pay corporate taxes.

An LLC, a Limited Liability Company, is a different type of business entity. Like a corporation, an LLC offers protection for the owners' personal assets in the event of lawsuit or debt. The owners—called members when the firm is an LLC—can collect their profits through the company without paying corporate taxes in many states. There is also greater flexibility in how profits can be distributed amongst the owners than in corporate structures.

Advantages of Incorporating

Incorporating protects your personal assets by separating them from those of the business. In the event of a company lawsuit or bankruptcy, your personal assets will not be at risk. LLCs offer similar protections.

So, if you are running a business that is at high risk for being sued or has risky finances and you have personal assets you would like to protect, it is wise to form a corporation or LLC. Of course there are some circumstances in which you can still be liable; you may also want to consider business liability insurance.

Corporations can also save you money in taxes. This savings can be substantial for firms that are realizing large profits.

Reasons to Wait

Suppose you decide you want to convert your business into a corporation or LLC. When is the best time to do it? Generally, since a corporation protects your personal assets, the answer is "as soon as possible." However, if it is very close to the end of the year, you might want to wait until the first of January. Why? If your business operated as both a sole proprietorship and a corporation during the year, you will have to file two tax returns—one for each type of business—and therefore incur additional tax preparation costs.

So, What's Best?

Whether it is best to incorporate or form an LLC depends the type of business you have, the owners, and your financial and business growth goals. An LLC is ended by the death or bankruptcy of a member, where a corporation continues without regard to these events. If you plan to issue shares of your business to other people, a corporation is the better choice.

Ultimately, there is no single solution that works for every type of business. If you feel it may be advantageous to convert your sole proprietorship to a corporation or LLC, consider all the variables and choose the entity type that will be most to your advantage.

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Comments

Submitted by Dave Taddei on Mar 5, 2010 - 7:41AM

I have an LLC and would like to covert to an S-sorp. What is the process? What are the considerations?

Thank you.

Dave

Submitted by Jack on May 31, 2011 - 9:27AM

I have a Virginia LLC set up and registered by LegalZoom. I
have single member LLC and would like to covert to an S-corp. What is the process? What are the considerations?

I would also like to have (appoint) two (2)additional members to the Virginia LLC. Each additional member will have an thirty percent (30%) equity and I will have the remaining forty percent(40%)equity in the LLC.

Are there any legal or filing costs associated with the above actions?

Thanks for your reply.

Submitted by phenze on Oct 6, 2011 - 7:47PM

please share comments

Submitted by Anonymous on May 8, 2010 - 2:57PM

I formed an Incorporation through legal zoom, but it has been an inactive company. I would like to convert it to an LLC and use it for buying and selling real esate, flipping houses. Is that possible? Also,do I need a real estate license to do this? Can I live in one of the homes I purchase to flip?
Thank you, please help.

Submitted by Sam on May 13, 2010 - 9:57PM

I have an existing two sole proprietorship companies (one owned by me and another owned by my husband) which sometimes creates problem in the mixed of transactions. Recently, I came up with a decision of of 1. to dissolve the other sole proprietorship and transfer the business to the other or 2. to convert it into a corporation. Pls help me which is advantageous to do and what would be the process for both?

Thanks.

Submitted by Tony on Jul 7, 2010 - 5:39PM

I have an existing two sole proprietorship companies (one owned by me and another owned by my husband) which sometimes creates problem in the mixed of transactions. Recently, I came up with a decision to dissolve the other sole proprietorship and transfer the business inventory only to the other business.the only debt on the business I want to dissolve is a credit card with both my legal business name and my own name as well and the balance is under $1000.00 at this time and am still paying it off.How can I go about this and close out the one business all together
Please advise
Thank You
Tony

Submitted by GV on Jul 31, 2010 - 8:31AM

Currently I own a condo in CA with my son-in-law. We purchased about 5 years ago as an investment. We are considering converting it to an LLC. My question is, would we still have the liability for the mortgage under the the LLC?

Submitted by Kathy on Dec 29, 2010 - 5:49AM

My husband is the sole owner of an S-Corp. For insurance reasons, we want to add my name as co-owner of the business. Can there be 2 owners of an S-Corp? What document(s) do we need to file in order to make the change in ownership? We are incorporated in PA.

Submitted by LegalZoom on Jan 6, 2011 - 2:41PM

Kathy,

It is possible to have more than one owner in an S-corporation, but no more than 100. Please contact a Business Services at (888) 381-8758 to speak with a specialist about making changes to your Pennsylvania Corporation.

Submitted by AL on Mar 26, 2011 - 6:56PM

Hello, I need info on changing ownership in a Pennsylvania S Corp. I found a related article ,however,the phone number I am directed to is incomplete.(888-381-858 ). Would you please supply the correct phone number. Thanks
AL BLUME

Submitted by phenze on Oct 6, 2011 - 7:54PM

want to add my wife to SUB S corp, in Calif, as co owner.

Can't figure the state procedure for this amendment?

Peter

Submitted by Annette on Jan 8, 2011 - 11:24AM

Just formed an LLC, how do I convert my houses, raw land, vacant lots to the company? Two additinal houses have amortgage, how do I convert to the LLC?

Submitted by Mildred OwensAnonymous on Feb 13, 2011 - 12:15AM

How do I change my company from a corporation to a proprietorship? I am the only person involved. I licensed my Company in July of 2010.

Submitted by LegalZoom on Feb 17, 2011 - 11:54AM

Dear LegalZoom Customer,

LegalZoom can assist you to dissolve your corporation filing with the Secretary of State’s office to close the entity. If you would like to form your company as a sole-proprietorship by filing a DBA (Doing Business As), LegalZoom can assist you with this as well. I have provided a link to our Dissolution and DBA informational pages for your reference.

Dissolution:
http://www.legalzoom.com/additional-business-services/articles-of-dissol...

DBA:
http://www.legalzoom.com/legal-dba/dba-doing-business-as-overview.html

If you have any further questions, please feel free to contact one of our Business Formations Department at (888) 381-8758 to speak with a specialist.

Sincerely,

The LegalZoom Team

Submitted by Joanna Lin on Mar 1, 2011 - 4:51PM

I incorprated my name April 2010, had DBA done for the corporation, and I had bank account set up for the corporation with the DBA in it. I want to dissolve my corporation. Do I need to do DBA and set up a new bank account?

Submitted by LegalZoom on Mar 4, 2011 - 11:36AM

Dear Joanna,

Thank you for contacting LegalZoom for your online business needs. We can assist you to dissolve your existing corporation as well as form a DBA (Doing Business As) Statement as a sole proprietorship or partnership. If you dissolve your corporation, you will need to speak with your bank about closing the account and re-establishing a business account under the newly formed DBA.

For your reference, We have provided our dissolution and DBA information for your reference.

Dissolution:
http://www.legalzoom.com/additional-business-services/articles-of-dissol...

DBA:
http://www.legalzoom.com/legal-dba/dba-pricing.html

If you have any questions about starting this process, please feel free to speak with a Business Services Specialist directly at (888) 381-8758.

Sincerely,

The LegalZoom Team

Submitted by Anonymous on Apr 19, 2011 - 4:37PM

I formed a LLC to my sell property, originally held 1st later, moved to 2nd on the note. If I disolve the LLC does my legal postion to collect the outstanding mortgage due change? Can the buyer now refuse to pay because I'm no longer LLC? Can I dissolve the LLC, assign it to my trust with no loss in ability to protect my interest in collecting the outstanding mortgage?

Submitted by Anonymous on May 12, 2011 - 7:03AM

I am a 50% owner of an S-Corp and I am leaving the corporation to my partner. He would like to keep the corporation himself with the same name but I need to remove my half from any further liabilities or profits. What do I need to do to have this done legally.
Thank you ,
Karl

Submitted by Jason on May 30, 2011 - 6:01PM

I'm currently the single owner/operator of a sole proprietor company. I wish to convert it to either an LLC or S Corp. How do I learn the pros and cons of each and which is a better fit for me? I'm leaning toward an LLC because it seems to be the most flexible. Can LZ help me understand each option, and then help with the conversion? Thanks.

Submitted by Chris on Jun 8, 2011 - 12:20PM

I'm a 50% owner of a LLP, and I'm leaving the business to my partner. He would like to keep the business w/ the same name, but I need to remove my half from any further profits or liabilities. What do I need to make this legit? Are there any LZ forms available?

Many thanks,
Chris

Submitted by Pat on Sep 9, 2011 - 3:20PM

I entered into a partnership agreement with another person in which we divided profits 50/50. Later, we verbally agreed to each operate the business 50% of the time and each realize 100% of the profits during during the period that we each operated the business. Did the partnership automatically change into a joint venture? Was the partnership agreement made invalid?

Submitted by Anonymous on Nov 4, 2011 - 12:48AM

Hello,
I have a question, my father in-law is listed under our state as Domestic Limited Liability co. (managed by managers)and wants to turn it into a partnership with my husband and my brother in-law can they turn it into a partnership and keep the LLC? How does that work and if it is possible what is the process?

Submitted by Steve on Nov 6, 2011 - 5:44PM

My partner and I formed an LLC in the last month or two. My partner has 51% and I have 49%. We would like to switch the ownership percentage to me having 51% and my partner having 49%. How can we accomplish this?

Thanks,

STeve

Submitted by manisha on Nov 23, 2011 - 2:33PM

Hi,
I started my business with DBA as soleproprietorship few days back and already applied for sales tax permit.But now I want to convert that soleproprietorship into a corporation? What will be the process? Can I use the same DBA for corporation and use the same sales tax permit for corporatio? I would really appreciatie your response in this matter.
Thankyou.

Submitted by Kurt on Dec 1, 2011 - 4:59PM

Have existing sole proprietorship with my wife listed as part owner. Have a FEIN. My wife recently passed away. Do I need a new FEIN if I convert to an LLC in my name only.

Submitted by David Evans on Dec 6, 2011 - 11:30AM

I am currently a DBA and would like to covert to an LLC or corporation. One of the people I need as a partner has an IRS problem and can not have a federal Id #. I have a federal ID # and Sate sales tax #. Can these #'s remain and just start the Corporation or are new fileings needed?

Submitted by Denise on Jan 17, 2012 - 5:56AM

I currently own a small business registered as a sole proprietor ship. It was a hobby business but had a lot of attention. The business is a farm animal rescue where we ran a mobile and on site petting zoo, pony ride business. Most of our business went to the site of the event, parties, city carnivals, businesses, schools, nursing homes, etc. If a group came to our location we offered hay rides, have a stocked fishing pond plus the petting zoo and pony rides. We also have a picnic area and restrooms.

I had to quit my business last year as I also work and my career was just taking on so much of my time and very stressful and being able to only run the small business on the weekend is VERY EXPENSIVE, especially because we rescue farm animals, I have taken in ponies that can cost me over $600.00 in 2 days just to get them the proper medical treatment they need.

I have made a life changing decision and have given up my career to follow my heart and work with the animals instead. I believe that if I am available full time, I can offer much more in this business and reach many more groups. I love to reach children, schools, special needs children and adults to teach the love of the animals, share them and also teach about animal abuse and responsibility.

So anyway, I think I need to change from sole proprietor to an LLC and I also need to get my 501C3. This is very expensive business and I need help to be able to continue to take in animal rescues.

Can you offer help with both and what kind of costs am I looking at? Keep in mind please that I have now quit my job, have no income and have high costs involved in animal rescue so cost will make my decision for me. Also, a payment type of plan may need to be considered.

Thanks for your time...

Denise

Submitted by Anonymous on Feb 1, 2012 - 3:50PM

can i convert my dba/ sole proprietorship to a llc with out losing my ratings with the bbb or credit


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