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Switching The Form Of Your Business
When you started your business, you had to choose one of several business entities: a sole proprietorship, partnership, limited liability company (LLC), "S" corporation, or "C" corporation. You and your accountant likely weighed several factors, including:
- The comparative ease and expense of forming each kind of business
- To what degree each might shield you from personal liability
- The tax benefits or drawbacks of each business set-up
- How many owners you had or planned to have,Whether passive investors had ownership stakes
- How much protection from creditors each entity would afford you.
After your business has been up and running for a while, it may be time to revisit your decision. As essential as it is to start with the right legal structure for your company, it’s also important to make sure it’s still the best one as your business grows and changes. Shifts in tax law or the business environment could also signal it’s time for something new.
No doubt you tried to anticipate how your business would develop, but there are bound to be surprises, and the business form that served you well five years ago may be inadequate today. Consider two painters who pooled their savings to open a paint store as a general partnership. They couldn’t have guessed they’d now have 15 stores in multiple states. In order to limit personal liability, it may be time for them to switch to a corporate form or an LLC. But they’ll also need to consider how those or other entities would fare under the laws of the various states in which they now operate.
For example, several years ago, when LLCs first became popular, this business structure was affordable and flexible. Since then, though, many states and local governments have heaped taxes and fees on LLCs, making them much less appealing for smaller businesses operating in those locales. Fortunately, switching out of an LLC tends to be straightforward.
Your tax and legal advisors can keep you abreast of changing rules and strategies you might use to your advantage. In some cases, you will have no choice but to adopt a new business structure. For example:
If you formed your business as an S corporation and now want equity financing from foreign firms or corporations, you’ll have to become a C corporation or LLC in order to admit these new owners.
If you’re one of several owners of a professional firm that decides to share profits according to each owner’s annual contribution to the bottom line, you won’t be able to use a corporate form. But partnership rules could accommodate this arrangement.
If your growing software company, formed as an LLC, decides to go public, you’ll have to become a C corporation.
While it may be relatively easy to terminate one business entity and form another, any such move is likely to have tax ramifications and other sometimes unintended consequences. So make sure to get expert help.