Many businesses start out as a sole proprietorship and, down the road, decide to change their business structure. Usually this means an LLC or an S-Corp, and sometimes a C-Corp. There can be both tax and liability advantages to making the change.
Deciding on the right entity type is a complicated issue and we won’t tackle it here. You will need the help of both an attorney and a tax accountant to help you decide on the right structure, depending on your individual situation and business. Once the decision to change has been made, though, there are some standard steps to take. Your attorney and tax accountant should help you with these, and be sure you have a plan in place to get these done before starting business in your new entity!
I do not recommend trying to set up your new entity yourself. Consult with the appropriate professionals. The tax benefits may not be as great as you think, especially considering the extra paperwork and the additional tax return preparation costs. The liability protection may also not be as good as you think, and insurance may be a better answer. If the new entity is a good choice, you will still want the advice of these professionals to make sure all the steps are completed, and the entity is set up correctly to take advantage of the tax and liability benefits.
Generally, it’s easier to make the change at the start of a calendar year. You will file your tax return as a sole proprietor one year, and as your new entity the following year. (NOTE: if you go from a sole proprietor to a single-member LLC, you may still file as a sole proprietor on your Federal tax return. LLCs are not recognized by the IRS and you will elect to file as a sole proprietor, a partnership if there is more than one member, or as a corporation). If you have employees, your payroll will be run under one EIN in one year, and the new EIN the following year. A clean transition at the end of the tax year makes for less paperwork. Check with your state employment department about running payroll under the new company. While you do need a new EIN for your Federal payroll taxes, your state may allow you to maintain your existing employer account.
Of course, it’s not always feasible to make that change at the end of the year, and most business start their new entity sometime during the year. The end of a calendar quarter is a good time, especially if you have payroll.
Once the new entity is set up, some of the steps to take before conducting business include:
- Filing for your fictitious business name, or modifying your existing fictitious business name so that it is now under your new entity. This is usually done with a county agency.
- Get your new EIN and set up payroll under that EIN. If you use a payroll company, notify them and work with them so they can get it set up correctly and on time to process the first payroll. If you process payroll yourself, check with your payroll service. If you run payroll from QuickBooks Desktop, for example, you can run payroll for up to 3 EINs under your subscription.
- Update any licenses you may have (business etc) to be under the new entity
- Update your banking and insurance services.
- If you have a seller’s permit, update that information with the appropriate agency.
The SBA has a good post on this topic: https://www.sba.gov/blogs/4-steps-changing-your-business-structure
Now that you’re ready to conduct business, what about the bookkeeping? You already have a system in place to run your business as a sole proprietor, such as a QuickBooks file. Can you just continue on using the same file?
Because this is essentially a new business, it is best to start a new QuickBooks file. If you are running payroll in QuickBooks, you will definitely want to start a new file as your payroll subscription is tied to the EIN, and the EIN on the file will need to change.
If you start a completely new QuickBooks file, you can export your lists from the old file to the new file. Accounts Receivable and Payable will need to be set up. If you have loans in your sole proprietor file, you will want to check with your attorney and accountant to see if they can legally be transferred to your new entity.
There may be an instance where you want to use the same file because of history or work-in-process that needs to transfer over. This can be done with some careful planning. You will also want to work with your tax accountant to make sure the old data gets converted to some opening entries that will work for tax return preparation. The process is to make a backup of the sole proprietor file, then restore it and give it a new name to reflect the new entity. Then you can change the EIN, legal business name, and tax form. You’ll need to add the EIN to your payroll subscription and set up payroll. Now you will have the original sole proprietor file and a new entity file. Again, work with your accountant on this! You can condense data in the new file before the business start date. There is an Intuit post with more details on this: http://dataservices.intuit.com/support/articles/how19766
This covers some of the things you will be dealing with when you change your entity type. While there are costs and a time investment involved in setting up correctly, they are small when compared to the cost and time to clean things up if they are not set up right from the start! Careful advance planning and consulting with the right people can make this a smooth transition.