Why Would You Change Your Firm’s Business Structure?

LIKE

0

LEAVE COMMENT 0

8 min read

Design firm owners have a few different options when it comes to structuring their businesses legally. Each business structure comes with its own advantages and disadvantages, many of which are situational. One business owner might choose to structure as a limited liability company while another might choose an S-Corporation. Of course, the structure you choose initially might not work as your business grows.

To accommodate increasing risk or lower their federal income tax bill, some owners opt for a business structure change. In this post, we examine a few reasons why business owners change legal structures and when it might be time for you to switch. When should you change your business structure? Follow below for a few insights that might help you determine the right time for your interior design firm.

When and Why Do Interior Design Business Owners Change Legal Structures?

Should you change the legal structure of your interior design business as it expands? Choosing the right business structure is essential to your interior design firm’s business success. Here are a few common reasons why a small business owner might change his or her business structure — and why you might change your own business structure in the future! 

#1 To Reduce the Tax Burden of Their Small Business

When classified as a sole proprietorship or partnership, all profits and losses from your interior design business are reported directly on personal tax returns. If your small business is registered as a partnership, profits and losses are reported on Form 1065. If a sole proprietorship, profits and losses are reported on Schedule C of Form 1040 of your personal federal income tax return. In many cases, business income for an interior design firm is taxed in a manner casually referred to as “pass-through taxation.” According to this resource from the Tax Policy Center, a pass-through entity can be a sole proprietorship, partnership, LLC or S-Corp.

Interior designers with pass-through income do not take wages from the business, but instead lump personal deductions and income with business deductions and income. You are “not subject to corporate income tax.” On top of their income taxes, sole proprietors owe self-employment taxes. To ensure they can afford to pay taxes they owe in April, sole proprietors must calculate and pay estimated taxes each quarter. 

Does Your Tax Bill Really Change When You Change Business Structures?

Some business owners who originally registered as a sole proprietor, partnership, LLC or S-Corp later choose to reclassify. They change business structures to reduce their tax burden. Under the Tax Cuts and Jobs Act, the corporate tax rate is a flat rate of 21%. That 21% flat rate is lower than rates for certain personal income tax brackets.

As noted above, many businesses classes as SP’s, partnerships, LLCs and S-Corps qualify for a pass-through deduction. However, business owners with higher incomes might end up with a lower overall tax bill if they reclassify as a C-corporation. 

Fuel your creative fire & be a part of a supportive community that values how you love to live.

subscribe to our newsletter

_{*please check your Spam folder for the latest DesignDash Magazine issue immediately after subscription}

Subscribe

The tax rate is different, but so is the manner in which business income is taxed. Diana Fitzpatrick, J.D. elaborates in an article for NOLO. Fitzpatrick writes that “owners of C corporations don’t pay tax on the corporation’s earnings” unless they themselves “actually receive the money as compensation.” This compensation can come in the form of “salaries and bonuses” or in the form of dividends. Taxes are paid only on profits “by the corporation itself.” 

Of course, the process of filing taxes as a corporation is far more complex than filing as a sole proprietor. Those considering the switch might consult with an attorney, accountant or financial planner before making any changes. The initial savings provided by a switch from the individual tax rate to the corporate tax rate can be significant.

However, they might not be enough to cover the cost of hiring an accountant or attorney. It’s important to weigh the costs and benefits for your interior design business before changing your legal structure solely for tax purposes. The interior design industry is complicated — as are tax implications for business owners in this space. Consult an interior design business coach and local tax professional before proceeding.

#2 To Limit Personal Liability and Protect Their Private Assets

The second most common reason why business owners switch business structures is to limit liability and protect assets. As a sole proprietor or simple partnership, creditors and/or claimants can come after your personal assets to satisfy debts or lawsuit settlements.

According to this resource from the U.S. Small Business Administration, sole proprietors have “unlimited personal liability.” Those who reclassify their business as an LLP, LLC, S-Corp or C-Corp can protect their personal assets from this type of attack if the proper measures are taken. 

Of course, limited personal liability does not mean business owners should abandon coverage provided by insurance. Businesses that reclassify to an LLP, LLC or corporation might still need general or professional liability insurance to protect their business from losses.

#3 To Secure Financing from a Bank, Credit Union or Other Financial Institution

Another reason why business owners switch to a new business structure when planning for growth is to secure financing. According to this Accion Opportunity Fund resource, any entity interested in buying into your business or “becoming a partner [will] want a formal structure.” This is because establishing a legal structure “involves setting out clear rights and responsibilities upfront.” With a formal business structure like an LLC or corporation, “everyone knows how the arrangement will work and what their options are.” 

Banks and other financial institutions also prefer business owners to define their legal structure before opening accounts or applying for loans. Switching from a sole proprietorship or partnership to an LLC or corporation can also help secure financing. This is because the owner’s assets and liabilities are distinct from those of their business. Your firm’s legal structure is often an important part of your interior design business plan when trying to secure a loan.

There are also legal issues involved when accepting outside investment as a sole proprietorship or partnership. As this Rocket Lawyer resource explains, “you can sell a portion of your business in exchange for capital investment” when your business is incorporated.” However, such investment opportunities are “simply not available when you keep your company structured as a sole proprietorship.” Most fundraising opportunities are closed to sole proprietors and partnerships.

#4 To Appear More Professional to Investors and/or Clients

Restructuring as an LLC, LLP, S-Corp or other corporation can appear more professional. In their article “Sole Proprietorship Vs. LLC: Here’s What You Need To Know” for Forbes, Leeron Hoory, Jane Haskins and Rob Watts explain. Hoory et al. note that incorporating can give your business “a sense of legitimacy” that is difficult to achieve when operating as an SP. 

They argue that communications and payments both appear more professional when the owner’s name is followed by an “LLC” or other legal acronym. Plus, it is typically easier to establish business credit as a corporation than as a sole proprietorship or simple partnership. 

#5 To Sell Their Business or Bequeath Their Business

Business owners might also choose to restructure as an LLC or corporation when planning to sell all or part of their business. Entity sales are typically more profitable for business owners than asset sales. However, entity sales are more difficult for businesses classified as sole proprietorships and/or simple partnerships.

Every business owner is advised to separate business income and expenses from their personal income and expenses. One key difference is that LLCs and other corporations actually require business owners to do so. 

This makes it easier for prospective buyers to understand the flow of money through your organization. Prospective buyers need not fish through the owner’s private accounts, tax returns and other information. As such, this approach also affords the business owner a greater degree of privacy and security.

Choosing to incorporate your business can also protect it from dissolving upon your death. Every legal structure does not offer a small business owner “perpetual existence” if her or she were to pass away or lose legal control over the business. Say you were to pass away or fall ill suddenly, but the business was classified as a sole proprietorship. If structured as an SP, it would be very difficult for heirs to either operate or sell the business.

If it were structured as an LLC or corporation, the business would be entirely separate from its owner. Heirs to the business could easily restructure, sell or continue operating the business after its original owner’s death or incapacitation. 

#6 To Expand or Restructure Their Business – But Not Necessarily to Relocate

If you plan to expand, downsize or restructure your business in any other way, it might be time to reclassify. Expansion – whether opening a second location, building another department or entering new markets – often means accumulating assets and increasing liability. Seeking greater protections for your business, your employees and yourself is a necessary step when expanding that business. Choosing a different legal structure can help.

#7 To Communicate the Company’s Mission or Values More Effectively

Some business owners choose to reclassify as a Benefit Corporation or nonprofit to communicate their company’s mission or values. Keep in mind that not all states authorize Benefit Corporations in the way they do LLCs, S-Corps and C-Corps. As of 2020, only thirty-five states – plus D.C. – recognize Benefit Corps as legal entities. 

For those unfamiliar with B-Corps, they are for-profit corporations – not nonprofits. According to this resource from B Lab, “a benefit corporation is a traditional corporation with modified obligations.” These modified obligations commit the corporation and its members “to higher standards of purpose, accountability and transparency.”

Restructuring as a nonprofit or B-Corp makes sense for certain organizations. This is particularly so for those committed to achieving some sort of social, environmental or other altruistic impact. However, not all organizations either meet the requirements or are best served by this type of legal structure. 

#8 To Add More Employees or Work With Independent Contractors

If a small business owner plans to hire more employees or IC’s, it might be time to transition from a sole proprietor to an LLC or corporation. Small businesses classed as sole proprietors can hire independent contractors and employees as long as they obtain an EIN.

For example, you might want to hire an interior design intern or commission small business coaching services. While the latter might not open your interior design business up to legal claims, the former could. Business owners often increase their liability when they add employees. When working with independent contractors, they can also incur legal penalties. 

As this resource from LegalNature explains, “you are responsible for your employees’ actions” as the business owner. If employees injure themselves on the job, damage property or harm someone else, you could be liable. In short, “employees add another layer of risk that makes asset protection an even more serious concern.” 

Fuel your creative fire & be a part of a supportive community that values how you love to live.

subscribe to our newsletter

_{*please check your Spam folder for the latest DesignDash Magazine issue immediately after subscription}

Subscribe

The potential risk posed by working with independent contractors as a small business owner is much different. There is a line – a blurry line, but still a line – between independent contractors and employees. A business owner could easily cross this line and unintentionally convert an IC into an employee in the eyes of the law. If so, they could incur major penalties for misclassification. 

In her article “Contract Workers vs. Employees: What Your Business Needs to Know” for Business News Daily, Jennifer Post explains. Post writes that misclassification will require a company to “‘pay back taxes as well as fines and penalties.’” These penalties are “‘based on the number of IRS Form W-2s that the company failed to file…and a percentage of wages.’” Though rare, “businesses could face criminal penalties” in extreme cases. 

If your business is structured as a sole proprietorship, you would bear the burden of these penalties personally. If structured as an LLC or corporation, the business itself would be responsible instead of the business owner.

Join the Community

Ready to elevate your firm? Join the DesignDash Community for advice and support from your peers and those who have navigated this industry for decades.

Not ready to join just yet but want to chat about it? Whether you own an interior design startup or an established firm, we would love to hear from you. Let’s work together to ensure your successful interior design business thrives like never before in 2025.