How to Change a Sole Proprietorship to an LLC

How to Change a Sole Proprietorship to an LLC

In the US, the most typical kind of company structure is the sole proprietorship. This is due to the fact that all it takes to establish one is to initiate company operations and see the revenue as a byproduct of self-employment. In essence, taxes are easy, and no documentation has to be submitted to the state.

However, you may want to look about converting your sole proprietorship into an LLC if you’re planning on buying a workspace, hiring staff, or bringing in partners. Adding individuals or valuable items to the mix increases your liability risk. A layer of security over your personal assets that is absent for a sole proprietorship is added when you convert to an LLC.

Sole Proprietorship vs. LLC

A sole proprietorship is a kind of company structure where there is just one owner who bears all liability risk in addition to keeping all business revenue. The proprietorship’s owner and the business are one and the same under this arrangement, and the owner is responsible for paying income tax on all company gains.

As an alternative, an LLC (limited liability corporation) may have one or more owners, referred to as members, who get all of the money produced by the LLC but assume all of the business’s liabilities. An LLC establishes a division between the owner and the company as a distinct legal entity.

Reasons to Convert From a Sole Proprietorship to an LLC

One of the main benefits of converting from a sole proprietorship to an LLC is the asset separation and personal liability protection offered by the LLC form. There are a few good reasons to consider changing the structure of your company.

You’d Like to Recruit Workers

Although a proprietorship may hire staff, doing so will complicate accounting and taxation considerably. You can more effectively keep personal and corporate tax and financial information separate with an LLC. Additionally, switching to an LLC will provide you an additional layer of security in the event that you run into legal issues with one of your employees.

You Desire to Safeguard Your Individual Wealth

You want to make sure it’s safeguarded, regardless of whether you had personal wealth before to starting the firm or as a consequence of it. When a proprietorship is involved in financial problems or is sued, your personal assets are at stake. Your personal assets are shielded from the business’s whole responsibility when you have an LLC.

You’d Like to Reduce Your Tax Bills

All business income is subject to self-employment taxes for the owner. These taxes may be expensive, depending on the company’s revenue. A proprietorship may choose to adopt S-Corp status in the event that it converts to an LLC. With this tax arrangement, members only pay taxes on a fair remuneration that the LLC pays them; rather than paying self-employment taxes on all of the LLC’s profits. The residual income is regarded as a dividend and is not taxed in the same way.

The Process of Converting a Sole Proprietorship into an LLC

If you believe that an LLC would be a better option for your expanding company, you should get acquainted with the procedures involved in making the switch. You have three options for forming an LLC: employ an attorney, utilize an internet service, or do it yourself. For the majority of company owners, using an online tool to complete and file paperwork may be a great way to save time and worry.

With a few minor variations, the procedure for forming an LLC is the same for both new and existing small company owners.

Step 1: Verify whether You Can Use That Name for Your Business

Checking whether the name your proprietorship has been using is available as an LLC name in your state should be your first step. You should look for LLC names on the secretary of state’s website in your state. If it is available, you must adhere to the designation term requirements set down by your state, which may include adding “LLC” or a similar phrase to your name.

Step 2: Obtain a Registered Agent

In the United States, all LLCs must choose a registered agent. On behalf of the LLC, this person is in charge of accepting significant financial and legal papers. You have the option of acting as your own agent or assigning the work to a licensed agent service.

Step 3: Submit documentation to the State

The next step is to submit the organizational paperwork for your LLC with the relevant state office, generally the secretary of state. The term “certificate of formation” or “articles of organization” are often used to refer to this document. Despite having various names, they share the same basic information:

  • Name and address of your LLC
  • Why you created your LLC
  • Name, address, and registered agent information
  • Organizational structure (managerially or by members)

You should file your organizational paperwork and then apply for your new company’s necessary business licenses. It is likely that you also need one for your sole proprietorship, depending on the nature of your business. You may need to apply for a new license, or this may be transferred to your LLC. See our state-specific instructions below for additional details on how to incorporate an LLC in your state.

Step 4: Create an Operating Agreement for Your LLC

Although not necessary in every state, drafting an operating agreement to guide your LLC is a smart idea. This is a contract that outlines the general terms and daily activities of the company between the member(s) and the LLC.

This is an excellent location to incorporate information on accounting data, ownership transfer terms, and voting rights. If your LLC is ever sued, having an operating agreement that outlines the business’s financial accounting can assist maintain its strong liability protection.

Step 5: Obtain an EIN

Finally, you want to think about obtaining an EIN (employment identification number) after creating an LLC. It is basically a free Social Security number for your company that you may get from the IRS. If your LLC has more than one member or if you want to recruit staff, you will need one. You won’t need one if your sole proprietorship converts to a single-member LLC, but if you want to accomplish any of the following, you could find it advantageous to get one:

  • Employing personnel
  • establishing a bank account for business
  • Transacting business with suppliers

FAQs

Can you switch from sole proprietor to LLC?

Absolutely! You’ll be changing from an informal business structure to a formal one. That means you’ll be officially forming a business under state law. Just follow the same steps for how to start an LLC in your state.

What are the disadvantages of changing from a sole proprietorship to an LLC?

The only disadvantage to changing to an LLC is the cost associated with filing. You’ll need to pay the filing fee for the initial formation paperwork and the annual report fees to keep your LLC active. This cost varies from state to state with the lowest state costing $40 to file and the most expensive state being $500. In some states, like California, LLCs cost up to $800 per year to keep active.

How do I transfer assets from sole proprietor to LLC?

As soon as your LLC is formed, your first step will be creating a business banking account for your LLC. Next, you’ll want to discontinue use of your sole proprietorship and only operate under your new LLC. Then you’ll assign the proprietorship assets to the LLC, which can be done in a few ways.

  • You can use the assets from the proprietorship to purchase ownership in the LLC (capital contribution)
  • Your LLC can purchase the assets from your proprietorship
  • You can use a transfer document (depending on the type of asset)

Either way, transferring assets can be a tricky business. Consider seeking legal advice from a local business attorney before making any moves.

When should I change from sole proprietorship to LLC?

You should consider changing to an LLC whenever your proprietorship decides to take on additional liability risk, which includes:

  • Taking on investors
  • Adding a partner
  • Hiring employees
  • Purchasing a workspace
  • Increased personal wealth

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