1. Incorporating a Sole Proprietorship
2. Pros and Cons of Incorporating a Sole Proprietorship
3. When Should You Incorporate a Sole Proprietorship
4. Transfer of Assets
5. Other Points to Remember

Updated October 28, 2020:

Incorporating a Sole Proprietorship

Changing from a sole proprietorship to a corporation helps protect the business owner's personal assets by separating them from those of the business. The level of protection varies depending on the type of corporation you select.

  • S corporations are often used for small businesses and aren't usually taxed at the corporate level but rather on dividends.
  • C corporations require you to pay corporate taxes, but you can also appoint a board of directors and issue company stock.
  • Limited liability companies (LLC) provide similar protection of personal assets, but owners (called members in an LLC) can receive their company profits without paying corporate taxes in some states. An LLC also allows for greater flexibility for profit distribution.

Pros and Cons of Incorporating a Sole Proprietorship

In a sole proprietorship, only one person owns the company. The owner doesn't pay corporate taxes on any profit but instead reports it on their personal income tax return. Some advantages of this business type include fewer regulations, less paperwork, simpler tax returns, and one profit beneficiary.

There are many advantages of incorporating a sole proprietorship besides separating your personal assets from your business, including:

  • Your personal assets are not at risk if there is a company lawsuit or bankruptcy. Note that you may want to consider business liability insurance because there are some cases in which you might be liable.
  • Corporations offer tax savings, which varies depending on the profits your corporation is realizing.

When Should You Incorporate a Sole Proprietorship

You can incorporate a sole proprietorship at any time of the year, but it is best to do it close to the beginning of the year because you must file a different tax return for each business type you operate during the year.

Transfer of Assets

Once you have created your corporation, you must transfer assets from your sole proprietorship to the corporation. It is important to remember to make transfers at a fair market value. Some assets might need a reputable valuation company to evaluate them. Doing this involves transferring shares of the new corporation to yourself, the owner of the sole proprietorship, to cover the amount of the assets being transferred.

Assets that are transferable include physical assets, such as property, equipment, computers, vehicles, and furniture, and also intangible assets and intellectual properties, such as the company's brand names, reputation, royalty agreements, trade secrets, trademarks, copyrights, patents, and long-term relationships.

Other Points to Remember

Incorporating your business is an exciting step, but the process can become complicated. It is particularly important that you properly document each phase of the process. Therefore, it's recommended that you consult an attorney to help you with closing the sole proprietorship and creating the corporation.

Some other points to remember for your new corporation include:

  • Employees transfer into the new corporation by “firing” and hiring each employee.
  • Close business accounts owned by your sole proprietorship and open new accounts for the new corporation.
  • Obtain a new federal tax identification number (FEIN) from the IRS. Depending on which state you incorporate your company in, you may also need to apply for a state tax identification number.
  • Cancel any insurance policies owned by your sole proprietorship and open new policies for the new corporation.
  • Notify clients of the change to your business, and update any existing contracts to match the name of the new corporation.
  • File articles of incorporation (for corporations) or articles of organization (for LLCs) for the state where you incorporate your company.
  • Dissolve the "doing business as" (DBA) in the state, city, or county where originally filed.
  • File a final tax return under the old DBA and request that the IRS close out the account and tax ID for the sole proprietorship. Do this after obtaining a new FEIN for the new corporation.
  • Update corporate documents, including letterheads, websites, business cards, telephone listings, and other contact information to reflect your new corporate information.

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