Is It Too Late To Incorporate Your Sole Proprietorship?

As the year comes to an end, perhaps you’re wondering whether you should form a corporation for your sole proprietorship. Or perhaps you’re planning to form a limited liability company and having it taxed as a corporation. You’ve probably heard about the potential benefits of incorporating, such as tax savings and liability protection.

But the year is almost over. Is it too late to make the switch?

It is not to late to incorporate your small business and have the incorporation take effect before the end of the year. However, the effective date of your new corporation or LLC cannot be retroactive to January 1.

For example, let’s say you decide to incorporate your sole proprietorship this year and you file the paperwork with your state on December 1, the official date of incorporation. The end result is that you must file two business income tax returns for this year – a Schedule C for January 1 through November 30, and a corporate income tax return (Form 1120 or Form 1120S) for December 1 through December 31.

So any tax advantages of incorporating will only be available to you for the month of December. In other words, incorporating this late in the year does not enable your business to be treated as a corporation for the entire year. Of course, you have done what is necessary to get your corporation up and running, and you’ll be all set to realize tax savings for all of next year.

You must ask yourself these questions: What are the potential benefits of your business being a corporation for the last few weeks of the year? And will those benefits outweigh the time and expense of filing two business income tax returns?

Also, don’t forget that when you incorporate, there’s a formidable mountain of tax-related paperwork. You must obtain a new federal identification number as well as new state account numbers. If you already have employees, you must begin issuing paychecks and making payroll tax payments under the new federal and state ID numbers. And you must start paying yourself as an employee of the corporation (assuming you are doing work for the business).

Of course, you’ll have to do all this paperwork even if you wait until January 1 to incorporate. It’s simply a matter of when it makes the most sense to do it.

For many self-employed folks, it may be better to incorporate as of January 1. Then you have a “clean break” with the sole proprietorship as of December 31.