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.

Most business owners get to a point where they have to determine whether it's best to structure their company as a sole proprietorship, a limited liability company (LLC), or an S corporation.

Those who have been operating as a sole proprietorship and decide to switch to an S corp.—after careful consideration of the pros and cons—should know that the process involves several steps. Here's some information to guide you in making the transition from a sole proprietorship to an S corp.

Man sitting at a table using laptop

Choose the State of Incorporation

An S corp., like any corporation, is created under state law. For this reason, you need to select a state in which to incorporate. Most small businesses only operate in one state and most often they incorporate in the state where they conduct their business operations. This is the simple way to proceed.

However, companies sometimes determine that there is some advantage to incorporating in another state—often for tax reasons or privacy concerns. The main drawback to incorporating in a different state is that you'll still need to register your corporation in any state where you conduct business. This means multiple state registrations, multiple state reporting requirements, and multiple state filing fees.

If your business will be operating in more than one state, you need to select one state in which to form your corporation and then register the corporation in any other state where you will conduct business.

Once you select a state in which to incorporate, you need to obtain more information regarding exactly how to incorporate in that state. You can obtain such information from the state's agency that regulates corporations and other business entities. In many states, this is the Secretary of State, but it may be called by other names in various states.

Select a Corporate Name

Every corporation needs a corporate name. This is the name that will be registered with the state as the official name of the corporation.

If you've been operating your sole proprietorship under your own name, you'll need to choose a name for your corporation. But if you've been operating your business under a DBA—also known as a fictitious name, assumed name, or trade name—you may want to continue using that name. Of course, you may also incorporate under a completely new name.

You'll need to check with your state's corporation agency to be sure that the name you wish to use is not the same as, or too similar to, a name already in use by another corporation. This can usually be done through your state agency's website.

File Articles of Incorporation

All states require a business to apply for incorporation by filing a particular form with the appropriate state agency. This form is most often called Articles of Incorporation, but may also be called by other names such as Certificate of Incorporation. You should be able to apply for incorporation online.

Obtain Federal Employer Identification Number

Since a corporation is considered a separate entity by the Internal Revenue Service (IRS), it needs to obtain a Federal Employer Identification Number (FEIN). This number is like a social security number for the corporation and is used for various state and federal tax filings.

A FEIN is required even if the corporation doesn't have any employees. It's obtained by filing IRS Form SS-4Application for Employer Identification Number, with the IRS.

Organize the Corporation

There are several things that you must do to organize any corporation and get it running. These include:

  • Creating corporate bylaws. Corporate bylaws are the basic guidelines for how the company will operate. Some, but not all, states require a corporation to have bylaws.
  • Issuing stock. This establishes the ownership interests of the shareholders. As the sole owner of the corporation, you'll probably begin by being the only shareholder. However, having a corporation gives you the opportunity to grow your business by issuing stock to new investors.
  • Setting up corporate books. This includes accounting records, stock ownership records, and records of the meetings of the corporation's officers, directors, and shareholders. These will be used for tax filings and to satisfy state corporate annual reporting requirements.

File for Subchapter S Status

Under federal tax law, corporations are considered as either C corporations or S corporations. This is a reference to Subchapter C and Subchapter S of the Internal Revenue Code. By default, all corporations begin as C corporations. To become an S corp., you'll need to file IRS Form 2553Election by a Small Business Corporation.

Transfer Business Relationships to the Corporation

Once your corporation is set up, you need to change all of your business relationships from the sole proprietorship to the corporation. In other words, you'll stop doing business as a sole proprietor and start conducting business as a corporation.

Keep in mind that at least one bank account must be opened in the corporate name.

There may be contracts or accounts between you as a sole proprietor and your customers, suppliers, utility companies, or others. Whenever possible, you should replace these with new contracts or accounts in the name of the corporation.

The corporation's officially registered name needs to appear on promotions. This includes print advertising, online listings, business cards, stationery, and any storefront or vehicle signage.

Converting a sole proprietorship to an S corp. requires some time and expense, but it's not a particularly difficult process. Many business owners find that the added personal liability protection, tax benefits, and growth opportunities make the transition worthwhile.

 

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.