Transitioning From a Sole Proprietorship to an LLC: What You Need to Know

Sole proprietorships make up a majority of small businesses that operate without employees. However, as a small business grows, it might be a good idea to change from a sole proprietorship to a limited liability company. But what exactly are the differences and how do you make the transition? Here’s everything that you need to know about transforming your business into an LLC.

Differences Between A Sole Proprietorship and An LLC

When tax planning for small businesses, you want to make sure that you’re making the right choices to help your business thrive as much as possible, and that could mean changing what your business is registered as. So what are the main differences between the two?

• Members: a sole proprietorship as one person; an LLC has one or more persons or business organizations.
• Taxation: for a sole proprietorship, sales and revenue are reflected on a personal tax return; for an LLC, personal assets are protected from liability for any business debts or obligations.
• Formation: a sole proprietorship is automatically formed when you start doing business; an LLC is formed when articles of organization are filed with the state.
• Legal entity: a sole proprietorship is considered the same legal entity as the owner; an LLC is considered a separate legal entity from the owner and its members.

Reasons To Transition to An LLC

A sole proprietorship may be simpler in form, but there are several reasons you may want to consider as to why an LLC may be better for business.

• You want to protect your personal assets: in an LLC, personal assets are not considered assets of the business, so they cannot be used to satisfy business debts.
• You save money on taxes: LLC owners only pay payroll taxes on their reasonable salaries, regardless of the company’s profits.
• You want to add a business partner: taking on a new co-owner creates a general partnership automatically, but it increases the risk of you being liable for business obligations. In an LLC, your personal assets are still protected when taking on a new business partner.

How to Transition to An LLC

The process does take time, patience, and money, but it’s best not to rush the process to ensure that everything is taken care of.

1. Confirm the business name. You should first ensure that your business name is available in the state where you plan to file your articles of organization. Just because you have the name for the sole proprietorship doesn’t mean that it’s available for an LLC.
2. File your articles of organization. These should be filed with the relevant state agency and the applicable filing fee should be paid. The articles are pretty straightforward and require information such as the name of the LLC, the address, its purpose, the name and address of the relevant agent, and the management structure.
3. Execute an LLC operating agreement. This is an agreement between all the members that dictates the rights and obligations of each member, in relation to profits and losses, specific voting rights, exit process, and retirement, for example.
4. Filing FormSS-4 to obtain an EIN. EIN stands for Employer Identification Number and is the number that the IRS assigns to you for tax filing and reporting purposes.

5. Applying for a new bank account. Because you are keeping the business and personal assets separate, it means that you need a separate account for the business assets.
6. Apply for business licenses and permits.

If you are thinking of starting the transition process to an LLC, be sure to speak to an attorney or LLC service to help make the process a little easier.

Photo by Austin Distel on Unsplash