Saturday, December 12, 2009

What's Involved in Changing a Business's Legal Entity?

This article was written by Dick Ginnaty, CPA

clip_image001So you decided to change the legal form of your business.  That is, you've been operating as a sole proprietor (or partnership, or an LLC) and you've decided to change to a corporation (or LLC, or partnership). What are some of the considerations involved in converting legal entity types?

First, you need to recognize that in a lot of ways it is like starting a new business. New tax identification numbers must be obtained such as new federal identification number (www.irs.gov) new state employer number (see www.edd.cahwnet.gov) and new sales tax reporting number (see www.boe.ca.gov).

In addition, accounts receivable and accounts payable from the old entity (in our example a sole proprietorship) would not carryover to the new entity as they are an asset and liability of the prior entity, and do not represent income or obligations of the new entity.

This issue will cause some confusion, and some overlap of bookkeeping.  You will likely find that you have to keep track of the new entities receivables and at the same time wind down the accounts receivables of the old entity. In many cases, the money collected from the old entity will have to be used to fund the new entity until collections of the new entity catch up.  This will often create a need to "loan" the new entity money on a short term basis to fund this startup period.  So in our example, the sole proprietor may need to lend money to the new corporation (with appropriate documents including an interest charge) to be repaid when possible.

Other considerations include deciding which assets of the old entity to transfer to the new entity.  It is not always the best idea to transfer all the assets of the old entity to the new one.  Items such as rights to names, patents, or trademarks may be better "licensed" to the new entity but not transferred (title wise) to the new entity.  In addition, certain assets acquired by the prior entity such as buildings, machinery and other valuable assets may be better protected from creditors or the risks of the business by keeping them outside of the new entity.

Planning is the key here, and you should consult your advisors when contemplating an entity change.

Good luck and here's hoping it "all adds up" for you.