How to Transfer Liability From a Sole Proprietorship to a Corporation

By River Braun, J.D.

How to Transfer Liability From a Sole Proprietorship to a Corporation

By River Braun, J.D.

Many businesses start out as sole proprietorships primarily because they don't require many formalities. These are simply businesses owned by one person, and that person is solely responsible for all of the business' liabilities. At some point, many businesses that start out as sole proprietorships transition to corporations in order to limit personal liability for the owners. Corporations, on the other hand, are businesses registered with the state that protect personal assets from being pursued for corporate debts.

Woman smiling at laptop

Here are the necessary steps to transfer liability from a sole proprietorship to a corporation.

1. Dissolve the sole proprietorship.

Depending on the state in which you are operating, sole proprietorships may not be registered with state agencies other than tax agencies. Check with your state business authority to determine dissolution requirements. If you did have to register your sole proprietorship, you must dissolve it.

If you obtained government-issued licenses, cancel those. You must also file final tax forms with the Internal Revenue Service (IRS) as well as state and local tax agencies if you obtained a separate tax identification number (TID) or employer identification number (EIN).

2. File articles of incorporation.

Locate the articles of incorporation on the business authority's website for the state in which you want to incorporate. This could be your home state or another state, such as Delaware, that has favorable corporate laws and well-established processes for corporate formation and operation.

Complete and file the articles of incorporation to establish the corporate entity and transfer liability. You need basic information about your business, including:

  • Business name. If you want to use the same name as your sole proprietorship, check with the state agency that regulates businesses to ensure the name is available.
  • Business purpose. This can be as simple and broad as "any lawful enterprise" or be very specific.
  • Business location. This is the address of the main office.
  • Incorporator names. Include the full names of each person involved in the corporate formation, not including employees.
  • Number of shares authorized for issuance. Don't be afraid to go big—10 million shares can give you a lot of flexibility when it comes to granting stock options.
  • Registered agent. Every corporation must have an official agent, whether an individual or a business, with an in-state address to receive important documents, including legal service. If the corporation does business in the state of incorporation, it may be its own agent.

3. Elect a board of directors.

The next step in forming your new corporation is to elect the board of directors, hold a meeting, and adopt the corporate bylaws, which define how the corporation operates. The bylaws should:

  • Describe the organizational structure of the corporation
  • Determine the rights and responsibilities of officers and directors
  • Outline the process of officer and director election or appointment
  • Explain the shareholder dispute resolution process

You keep the corporate bylaws at the principal corporate office and do not need to file them with government agencies.

4. Obtain an EIN and convert your financial accounts.

Once you form your corporation, fill out the Application for Employer Identification Number (Form SS-4) and submit it to the IRS either in person, by fax, or by mail. Alternatively, you can apply online via the IRS website.

After you've obtained an EIN, you can either convert your sole proprietor financial accounts to corporate accounts or close them down entirely and start from scratch. Starting with a clean financial slate is the best policy.

After following these outlines steps, you'll be able to transfer liability from a sole proprietorship to a corporation. Once your corporate accounts are open, deposit operating capital. Be sure to adequately capitalize your new corporation. Undercapitalization is one factor courts can use to "pierce the corporate veil" and make corporate owners personally liable for corporate debts and obligations.

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.