Incorporating a sole proprietorship is an important step in growing a business. A sole proprietorship is the most common way to structure new businesses because it is very simple to form. In fact, starting a sole proprietorship doesn't require any formal paperwork.

Many people don't even realize that they own a sole proprietorship. As soon as you sell something, you become a sole proprietorship. If you start selling handmade quilts from your basement, you automatically become a sole proprietor. Many cities and states allow business owners to register their sole proprietorships under a business name or DBA for a small fee, but it isn't required.

Pros and Cons of a Sole Proprietorship

A sole proprietorship allows the seller to hold on to all the profits, but it also holds the seller responsible for the debt, losses, and liabilities of the business. Investors are often wary of funding sole proprietorships because they don't have any protection in case of liability.

The business owner and the business itself are considered a single entity. Instead of having to pay corporate taxes, the owner of the sole proprietorship is the only owner and is required to pay personal income tax on any profit from the business.

There are a number of advantages to owning a sole proprietorship, including:

  • Less paperwork and regulations, which makes tax returns much easier
  • Simple to form
  • No bureaucracy or office politics because you get to make all of the business decisions
  • The profits belong solely to the single owner
  • Quick and inexpensive way to try a new business idea

However, there are also disadvantages to being a sole proprietor. The main drawback is that the owner also owns all of the liabilities of the business.

How to Turn a Sole Proprietorship Into an LLC or a Corporation

The first step in incorporating a sole proprietorship is to complete the formation documents. For an LLC, this is the articles of organization. For a corporation, it is the articles of incorporation. Then the documents must be filed with the correct state agency. You'll then need to dissolve your sole proprietorship DBA, if you filed one. Contact the appropriate government agency in your area to find out how. It's a simple process that can often be done online.

Your new LLC or corporation will require a new Employer Identification Number, also called an EIN or FEIN, from the IRS. This can be done through the IRS website or by filing Form SS-4 with the IRS.

In order to transition to an LLC or corporation, you have to file a last return with your old DBA and request to close the corresponding account with the DBA tax ID. It can be helpful to have a tax professional assist with this step and notify the IRS to close the DBA account.

Transitioning to a New Business Structure

Once the legal transition is completed, you need to move the rest of the company. Start by changing all accounts to the new name of the company. This can be the same name but should have "LLC" or "Corp." at the end, depending on the type of organization you are creating. You'll need to change the name on your bank accounts, vendor agreements, accounts payable, mailing addresses, and more.

This process can be time-consuming and tedious, but it is critical to establishing your new business. By changing the structure, you are not only legally protected from being liable for business debt, but you also gain credibility with customers and vendors that can pay off in the long run.

The next step is to update the contact information on your website, business cards, online listings, letterhead, and any other branded materials. Many people take this as an opportunity to completely rebrand and create a new logo or color scheme.

Once the official transfer is complete, there is still a long list of things that need to be done so that your company can truly act like an LLC or corporation. This includes doing things like:

  • Transferring the assumed name
  • Managing worker commissions
  • Closing old bank accounts and opening new ones
  • Updating insurance policies
  • Transferring licenses and permits
  • Fulfilling any obligations from contracts
  • Applying for a new federal tax ID number
  • Making changes to retirement and estate planning documents

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