How to Convert to S Corp. from Sole Proprietor

By Tom Speranza, J.D.

How to Convert to S Corp. from Sole Proprietor

By Tom Speranza, J.D.

If you own and operate a business as a sole proprietorship, converting your enterprise to an S corporation can be a wise move. Converting to an S corporation preserves some of the advantages of a sole proprietorship, such as pass-through taxation, while also protecting you from personal liability. It also allows you to admit additional owners or investors into your business venture.

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Converting a Sole Proprietorship into an S Corporation

An S corporation is a federal law concept that allows an existing corporation to be taxed as a partnership with the U.S. Internal Revenue Service (IRS). If a corporation elects S corp. taxation, the corporation does not pay federal income tax as a separate entity but, instead, its income and losses pass through to its shareholders. The shareholders then include such items on their individual tax returns.

The process for forming a corporation is pretty similar in most states.

1. Choose a state and a business name.

In most cases, you'll form your new corporation in the state where you live, but there might be a situation when a different state makes sense. For example:

  • Your company is buying a business or property in another state.
  • Your company is admitting investors who prefer a well-known business jurisdiction such as Delaware or New York as the corporation's governing law.
  • You want certain benefits offered by a tax-friendly state such as Delaware or Wyoming.

Before forming, you must choose a name for your corporation, and state laws require corporations to have relatively unique names to avoid confusion. Most states have an online database where you can search for available names.

2. Engage a registered agent.

Each corporation must have a registered agent located in the formation state to provide the government, tax authorities, and private citizens and companies a permanent, reliable location to send mail and legal documents to the corporation.

You can appoint yourself as the company's registered agent if you live in the formation state, but most corporations hire a corporate services company as the registered agent.

3. File articles of incorporation.

Corporations form by filing articles of incorporation, sometimes called a certificate of incorporation, with the state office in charge of business entities, usually the Secretary of State. States often provide sample forms on their websites.

Federal tax law requires S corporations to comply with specific requirements that must be reflected in the articles of incorporation. For example, an S corp. must have only one class of stock and cannot have more than 100 shareholders. In addition, S corp. shareholders must be individuals, certain trusts, or estates and must not be nonresident aliens.

4. Capitalize the corporation and draft initial documentation.

Once your corporation exists, you contribute the business assets you own personally in exchange for shares of stock. Contributions are usually documented with a bill of sale or simple contribution agreement. The company issues a stock certificate to you—and any other shareholders who may invest—and records it in the corporation's stock transfer ledger.

Your new corporation then needs to draft a few other legal documents in addition to the articles of incorporation. These include:

  • Bylaws, which spell out the rules by which the stockholders, directors, and officers manage the company
  • Initial resolutions of the shareholder(s) electing directors to the board and adopting the bylaws
  • Initial resolutions of the directors appointing officers

5. Elect S corp. taxation and complete other tax requirements.

Your corporation must apply for an employer identification number (EIN), which is a federal tax identification number and often likened to a Social Security number for your business.

After issuing stocks and receiving an EIN, your business can elect S corp. taxation. To do this, you must file for Election by a Small Business Corporation under section 1362 of the Internal Revenue Code (Form 2553) with the IRS. You are required to provide various details about the corporation on the form and have all of the corporation's initial shareholder(s) sign it.

An attorney may help if you want to correctly draft your S corporation's formation documents to ensure you establish a company that is eligible for S corp. taxation. Once your filings are complete and the conversion is approved, you'll continue to receive the same benefits you had as a sole proprietor while reaping the rewards of business expansion, like admitting new members into your venture.

This portion of the site is for informational purposes only. The content is not legal advice. The statements and opinions are the expression of author, not LegalZoom, and have not been evaluated by LegalZoom for accuracy, completeness, or changes in the law.