Your business needs change over time. When it comes to your business structure, the ideal thing is to pick the right one from your first day in business, but you might have decided to keep things simple at the beginning. It’s often hard to anticipate your business needs down the road. What used to work during your first few years in business may not be what’s best for your revenue and business growth now.
Your business, like you, is constantly evolving. That’s why it’s important to re-evaluate the procedures you set in place and cut out what’s not working, while doing more of what works well. With the right support, this doesn’t have to be a complex process.
Here are some common business structure conversion scenarios:
Sole Proprietorship to an LLC
My client John had launched a consulting business last fall. He didn’t form an official business entity, so by default he had a sole proprietorship. He learned during our consult that this business type put his family’s assets at risk in the event a client sued his business or he couldn’t pay company bills.
To minimize his personal risk, John decided to form an LLC (Limited Liability Company). An LLC, like a Corporation, separates the business owner(s) from the business. Most LLCs are “pass-through” entities, meaning that their owners (called “members”) pay taxes on the income of the LLC. The business itself doesn’t pay taxes on its income.
In this case, John needs to file the Articles of Incorporation (also called Articles of Organization) with his state. Also note that if his sole proprietorship was operating under a different name (like Red Tree Advice) using a DBA (Doing Business As) and he wants to continue using that name, then John needs to open a DBA under the LLC.
C Corporation to an S Corporation
Cara created a corporation for her online retail business, and was shocked to find out she was paying double the taxes she needed to pay. As a C Corporation, her business paid taxes on profits, and on top of that Cara also had to report her portion of business profits on her individual tax return, resulting in “double taxation.”
We were able to lower her taxes using the pass-through tax treatment of an S Corporation, because S Corps aren’t subject to federal income tax. Instead, the S Corporation is considered a pass through entity as is the LLC, and the company shareholders of the S Corp pay income tax on their share of the profit.
Just keep in mind that changing from a C Corporation to an S Corporation can be time sensitive because it is processed with the IRS, not the state, and only affects your taxes. You need to file IRS Form 2553 no more than 75 days from the date of incorporation, or no more than 75 days from the start of the current tax year.
LLC to a Corporation
Samantha launched a tech start-up five years ago. At the time, she was just looking to minimize her personal liability and keep things as simple as possible so she formed an LLC. Years later, her business grew and she started considering funding options.
Before Samantha began working with outside investors, we switched her LLC to a C Corporation. It’s important to make the change before getting funding, since it gets way more complicated to switch business structures after others are involved in the company ownership.
It’s Easy to Change Your Business Structure
There’s no reason to stick with a business structure that no longer works. In fact, the process is easier than you probably think.
Remember that any changes can have a significant impact on your taxes. So when consulting with your attorney about changing your business structure, it’s best to also speak with an accountant about your particular situation.