J.K. Lasser's Small Business Taxes 2013: Your Complete Guide to a Better Bottom Line

Changing Your Form of Business

Suppose you have a business that you have been running as a sole proprietorship. Now you want to make a change. Your new choice of business organization is dictated by the reason for the change. If you are taking in a partner, you would consider these alternatives: partnership, LLC, S corporation, or C corporation. If you are not taking in a partner, but want to obtain limited personal liability, you would consider an LLC (if your state permits a 1-person LLC), an S corporation, or a C corporation. If you are looking to take advantage of certain fringe benefits, such as medical reimbursement plans, you would consider only a C corporation.

Whatever your reason, changing from a sole proprietorship to another type of business organization generally does not entail tax costs on making the changeover. You can set up a partnership or corporation, transfer your business assets to it, obtain an ownership interest in the new entity, and do all this on a tax-free basis. You may, however, have some tax consequences if you transfer your business liabilities to the new entity.

But what if you now have a corporation or partnership and want to change your form of business organization? This change may not be so simple. Suppose you have an S corporation or a C corporation. If you liquidate the corporation to change to another form of business organization, you may have to report gains on the liquidation. In fact, gains may have to be reported both by the business ...