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The quickest way to get your business up and running is to opt for a sole proprietorship structure and transitioning into an LLC is relatively easy if the need arises. The changes between the two pivot around taxation and personal liability regarding your business operations.
How to Switch from Sole Proprietor to LLC
- Seek professional advice: You may not need to change your business structure.
- Seek professional advice - Changing your business structure might save you money and offer certain tax benefits.
Step One: Decide if an LLC is Right for You
Before jumping into how to change a business from a sole proprietorship to an LLC, it’s important to decide if an LLC is right for you.
- Consider your business risks: Different business operations have different levels of risk. As an LLC, you can insulate your personal assets from risk of loss if the business cannot pay its debts or cover the costs of a lawsuit. If your business has risks involved, then forming an LLC could be the right move.
- Consider your tax obligations: With a sole proprietorship, the owner must pay self-employment tax of 15.3% on all profits, plus income tax. With an LLC, you have tax options. One of these options is to have your LLC taxed as an S Corp, which must pay self-employment tax on a ‘reasonable salary.’ The remaining income can be sent to the owner as a distribution, which only requires a regular income tax payment.
- Look into the limitations: In many states, certain professionals cannot form an LLC. For example, many states don’t allow licensed professionals like attorneys and doctors to form an LLC.
If you require more information to make your decision see sole proprietorship vs LLC.
Step Two: Choose a Business Name
If you decide that you want to move forward with forming an LLC, it’s time to select a business name.
- Check the availability: Although you’ve been operating your sole proprietorship, you’ll need to check that your business name is available for use. Usually, you can find this information through your state’s business filing office.
- Check for trademark infringements: Take a minute to make sure that your chosen name doesn’t infringe on any trademarks.
- Ensure the name includes LLC: The business name should indicate that the company is an LLC.
- Avoid any restricted words: Many states forbid you to include certain words. A few common restrictions include ‘Bank’ or ‘Insurance.’
- Generate Alternatives: The name you want may be unavailable but a close variation might be available. Brainstorm a handful of names close to the name you really want.
Step Three: Designate a Registered Agent
Before you can file the paperwork, you’ll need to choose a registered agent.
- Purpose of a registered agent: A registered agent can accept legal documents for your LLC. You must list this person in the LLC filing paperwork and will primarily serve as the address for the business - you can not use a POBox.
- Can you be your own registered agent? Yes, most business owners function as registered agents for their business.
Step Four: File Articles of Incorporation
Now it’s time to make things official.
- What are Articles of Organization? Articles of Organization are the official documents you file with the secretary of state to open your LLC. It includes your company name, address, purpose, registered agent, a start date, and more. Sometimes these are called Certificate of Formation or Certificate of Organization.
- Where to file your Articles of Organization: You can file this paperwork with your state’s business filing agent. In some states, this is the Secretary of State’s office.
Step Five: Create an LLC Operating Agreement
After you file your Articles of Organization, you can move on to create an LLC Operating Agreement.
What is an Operating Agreement? This document indicates the ownership shares and the duties of each LLC member. It will help things run smoothly.
What’s included? You should outline the organization of the company, management, voting rights, capital contributions, distribution policies, membership change procedures, and a dissolution plan.
Where to send it: You don’t have to send your LLC’s Operating Agreement anywhere. But it’s a good idea to create it to prevent future conflicts between members.
Step Six: Announce Your LLC
Some states require you to publish a public notice about your new LLC.
Where is this required? If you form an LLC in Arizona, Nebraska, or New York, you are required to announce your LLC.
Where to publish this? In most cases, your local newspaper will suffice. But the requirements for each state vary.
Step Seven: Acquire the Necessary Licenses and Permits
If you were already running a sole proprietorship, then you likely already have the necessary licenses and permits. But when you create an LLC, you’ll need to update those documents with information about your new business.
May need to get new permits: Some states require an entirely new application process.
May just need to update your existing permits: Other states allow you to simply update your existing permits and licenses with your new LLC information.
Step Eight: Register with the IRS
After you’ve created your LLC, the next piece of the puzzle is to uncover how to change from a sole proprietor to an LLC with the IRS.
- Get your EIN: If your sole proprietorship had an EIN, you’ll need to get a new EIN. If you didn’t have an EIN, you’ll still need to apply for one with the IRS.
- What is an EIN? An EIN, or Employer Identification Number, is used by the IRS to identify your business for tax purposes.
Step Nine: Open a Business Bank Account
Separating your business dealings from your personal transactions is an essential part of LLC ownership.
- Use your EIN to open a bank account: Most banks will require an EIN for businesses opening a business bank account.
- Maintain distinct separation: You don’t want to blur the lines between your personal accounts and business accounts. Keep everything separate to avoid future headaches.
Step Ten: Transfer Assets from Yourself to Your LLC
With your business bank account open, it’s time to transfer assets into your LLC.
- Separating personal and business assets is critical: Without clear separation, you might lose the power of your LLC to shield your personal assets.
- Transfer business assets into the LLC immediately: Once the account is open, move over any assets. Additionally, transfer the title of any physical property into the LLC’s name.
Step Eleven: Cancel Your Sole Proprietorship
Depending on your situation, you may need to cancel your sole proprietorship.
- Withdraw your sole proprietorship DBA. If you had a DBA registered for your sole proprietorship, then your state may require you to cancel it by filing some paperwork.
- Stop using personal assets for business expenses: At this point, you should have your business accounts up and running to handle business expenses.
Step Twelve: Assess Your Insurance Needs
As a new entity, your LLC may need additional insurance. A few common options include:
- General liability insurance: This protects your business from claims involving bodily injury to someone else, property damages, or personal injury.
- Business income insurance: As a business owner, this insurance policy protects your income if a covered event prevents you from operating the business.
- Professional liability insurance: If you are sued for a mistake, this policy type offers protection.
Step Thirteen: Update Your Contracts and Agreements
If you have existing contracts or agreements in place for your sole proprietorship, then it’s time to update them.
Notify clients and providers of the change: You should update contracts or insurance policies when you make the switch.
Step Fourteen: Change Your Marketing and Other Materials
After filing to form an LLC, you’ll need to update your marketing materials.
- Materials to update: You’ll need to update your website, business cards, letterheads, Google listing, and more.
- Let customers know: You can also mention this change to customers. This is actually a great marketing opportunity for you.
Step Fifteen: File a Final Tax Return for Your Sole Proprietorship
- Final return: Write ‘final return’ at the top of your last Schedule C for your sole proprietorship. See sole proprietorship taxes for further details.
- Good practice: This indicates to the IRS that your sole proprietorship is closed.
Advantages of Changing from a Sole Proprietorship to an LLC
Making the switch from a sole proprietorship to an LLC comes with several benefits, including:
- Liability protection: An LLC protects your personal assets from business debts and lawsuits.
- Taxation options: As an LLC owner, you have opportunities to limit your tax obligations.
- Reputation: The separation between your personal and business assets makes it easier to attract investors and take out business loans.
Disadvantages of Changing from a Sole Proprietorship to an LLC
But there are some disadvantages to making this switch, including:
- Increased paperwork requirements: The separate entity requires regular filings with your state. An increased level of complexity makes an LLC the wrong choice for some business owners.
- Increased costs: The cost of filing information about your LLC each year can add up quickly.
- Not available for everyone: Some professionals, like attorneys and doctors, are barred from creating LLCs in some states.