The business structure you choose impacts your day-to-day business operations, taxation, personal liability protection, and everything in between. Therefore, you should choose an entity type that offers the best of legal protections and tax benefits.
Though the ideal course of action is to pick the right business structure at the onset of your business, that’s not always the case. When you set up a business, you create a plan to build, nurture, and grow it. You set your own set of business goals in terms of growth, scalability, and infrastructure, but it’s often hard to anticipate how things will actually turn out in the coming years.
As your business grows, your initial business structure might not be the best for your operational, taxation, or profit-sharing needs, and you may consider changing your business structure.
But the question is why should you change your business structure? Picking a legal structure for your business is a difficult decision, but what’s more difficult is to decide to change your current structure. However, there are a few possible reasons that may compel you to change your business structure.
Did you choose a simple legal structure for your startup? It is common for startup owners to choose a sole proprietorship or partnership as their business structure as these simple business structures are sufficient to meet their startup needs.
What does that mean?
Though they are easier to form and manage, they have their own limitations. Sole proprietorships and partnerships are ideal for one or two company owners without employees, but they don’t protect owners from personal liabilities. As your business grows, you may need to change your business structure to a more complex one such as an LLC or a corporation for this reason.
Personal Asset Protection
Many business owners change their business structure to protect their personal assets. This is because when your business grows, you hire more employees, build more infrastructure, and manufacture more products. All of this causes your liabilities to increase. As the aim of running any business is to earn money and build your personal wealth, you need to protect your personal assets from business liabilities.
To minimize personal liability, you can consider restructuring your business as an LLC or a corporation. However, some business owners buy business insurance to mitigate risks and cover any business losses. If buying business insurance can help protect your personal assets, you may not have to restructure your business.
Another major reason why you may want to change your business structure is to save money on taxes.
Have the taxation needs of your business evolved because of increased profits, an expanded workforce, or greater operational expenses? If so, you might need to change your business structure from a sole proprietorship or a partnership to an LLC or a corporation as these business structures offer more tax flexibility and advantages than the former, simpler business structures.
As a corporation, you can deduct overhead expenses such as office rent from your tax liability. However, you will need to pay taxes as a company and as an individual on your share of the company profits. Forming an LLC can save you from double taxation as this business structure offers pass-through taxation, which means that you need to report your share of the LLC earnings on your personal tax return.
Whether the reason is company growth, personal asset protection, or tax flexibility, it is a good idea to change your business structure to the most appropriate one. How should you decide on the new business structure? Let’s find out.
Things to Consider When Changing Your Business Structure
Before you restructure your business, you need to wait for any of the reasons that we’ve discussed to pop up. When that happens, you should plan ahead and make the required structural changes to grow your business.
However, you should consider the points mentioned below to decide on your new business structure.
Do you need better personal liability protection? Which business structure can best protect your personal assets? If these are your concerns, you’ll probably need to choose between a limited liability company and a corporation to minimize personal liability.
Before you change your business structure, you should ask yourself:
- How much profit is your company generating?
- What are your overhead expenses?
- Can forming a corporation help reduce your tax liability?
- Will you spend more on double taxation than what you’re paying now in taxes?
- Is forming an LLC a better option?
These points will help you choose the right structure for your business that offers maximum tax benefits.
Restructuring your business requires that you file documentation with the state. Whether you’re changing your business structure to an LLC or a corporation, you need to file Articles of Organization or Articles of Incorporation with the Secretary of the State’s office.
To make it easier for you, you can take advantage of the business formation packages by GovDocFiling to fulfill the legal requirements. They not only offer expedited application processing, but also cost less than hiring a tax accountant or a lawyer.
However, registering your new business structure with the state isn’t enough.
You also need to:
- Register with the IRS for an updated Employer Identification Number (EIN)/Tax ID.
- Update your business bank account records to reflect your new business structure.
- Update your new structure in your business insurance records.
- Create or update operating and partnership agreements.
- Complete all of the paperwork related to tax and legal requirements.
- Contact your suppliers and vendors and update the contracts and agreements to reflect the new structure.
You may also consider hiring an accountant for your business to manage ongoing paperwork.
You should also consider the state and federal filing fees involved in restructuring your business.
In fact, you should also consider the cost of:
- Creating new agreements and contracts that are necessary to protect you from any legal hassles later.
- Taxation costs.
- Ongoing reporting and record-keeping costs.
Are You Ready to Switch to a New Business Structure?
In this article, we’ve discussed the reasons that may cause you to change your business structure, and we’ve also talked about the factors you should consider while changing it. Now it’s your turn to examine the structural needs of your business and analyze whether or not your current structure meets them. If not, it may be time to restructure your business and take advantage of the opportunities another legal entity type offers.