How to Change a Partnership to a Sole Proprietorship
Understand the procedural framework for converting a partnership into a sole proprietorship, ensuring a compliant and seamless operational transition.
Transitioning from a partnership to a sole proprietorship requires formally dissolving the original business structure. A partnership is owned by two or more individuals who share profits and liabilities, while a sole proprietorship has a single owner personally responsible for its debts.
Dissolving the Partnership Agreement
The first phase of converting to a sole proprietorship is the formal dissolution of the partnership, which begins with a partner buyout. A key step is determining the fair market value of the business, which often requires a professional appraiser to ensure an objective price is set for the departing partner’s share.
Once a value is established, the terms of the buyout are documented in a formal sale agreement. This document specifies the final purchase price and the payment structure, which could be a single lump-sum payment or an installment plan over a set period.
Parallel to the buyout, a comprehensive accounting of all partnership assets and liabilities must occur. The distribution of these financial elements should follow the terms laid out in the partnership agreement. If the agreement does not specify these terms, partners must negotiate a new dissolution agreement to dictate how debts will be settled and assets will be divided.
The culmination of these negotiations is a written dissolution agreement signed by all partners, which serves as the official termination of the partnership. It details the final terms of the buyout, the settlement of all outstanding liabilities, and the distribution of any remaining assets.
Required Information and Documentation
With the internal dissolution settled, you must prepare documentation for government agencies. A key requirement is filing a final federal tax return for the partnership using Form 1065, U.S. Return of Partnership Income. On this form, check the box indicating it is a “final return” to notify the Internal Revenue Service (IRS) that the partnership has ceased operations.
A partnership’s Employer Identification Number (EIN) cannot be transferred to the new sole proprietorship, so you must close the business account associated with it. The new sole proprietorship will use the owner’s Social Security Number (SSN) for tax purposes. A new EIN is only necessary if the business plans to hire employees or file certain excise tax returns.
You must also prepare to formally dissolve the partnership with the state authority where it was registered, typically the Secretary of State. This involves a specific dissolution form. Concurrently, you may need to prepare registration for a new “Doing Business As” (DBA) name if you plan to operate under one.
Executing the Business Structure Change
After preparing all necessary forms, the next stage is to formally submit them to the appropriate government bodies. The final Form 1065 must be filed with the IRS according to its standard procedures, either through e-filing services or by mail.
If a new EIN is required, an application can be submitted to the IRS. The fastest method is via the IRS’s online application portal, which can provide an EIN immediately. Alternatively, the form can be submitted by fax or mail.
The partnership dissolution paperwork must be filed with the designated state agency, often by mail or through an online business portal. Similarly, any new registration for a DBA name must be filed according to that state’s specific procedures. Completing these filings officially terminates the old business entity.
Post-Conversion Business Operations
Once the legal change is complete, you must update the business’s operational framework. Close all financial accounts associated with the former partnership, including bank accounts, credit cards, and lines of credit. New business accounts must then be opened under the sole proprietor’s name and their SSN or new EIN to keep finances separate.
Next, review and update all federal, state, and local business licenses and permits. Many of these credentials are tied to the partnership’s now-defunct EIN and are likely invalid. You will need to contact the issuing agencies to determine if the existing licenses can be transferred or if you must apply for new ones.
Finally, communicate the change in business structure to all relevant stakeholders, including employees, customers, suppliers, and vendors. You must also inform your business insurance provider to update your policies. Updating contracts and agreements to list the sole proprietorship as the legal entity is also necessary.