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How to change a sole proprietorship to an LLC

Are you thinking about switching from a sole proprietor to an LLC to expand your business but don’t know where to begin? Learn how by reading our article.

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There are many reasons why a business owner may want to change their business structure from a sole proprietorship to LLC. However, not all business owners know the process of how to make these changes and whether it is worth doing so for the benefit of their expansion. Therefore, to learn more about how to change a sole proprietorship to an LLC and the pros and cons of doing so, keep reading. 

Sole proprietorship vs. LLC

Before changing a sole proprietorship to an LLC, it is vital to understand their differences and the pros and cons of each type of structure. 

Sole proprietorship

A sole proprietorship is a business that is owned by one person who pays personal income taxes to the government. Under the law, the business operator, and the business itself is seen as one legal entity. Therefore, for taxation purposes, a sole proprietor would file self-employment taxes. 

Pros:

  • There is a single owner, and it is easy to keep business secrets.
  • The owner can make fast decisions as he is the only boss.
  • There are low start up costs and the business structure is simple to operate.
  • The profits earned are not shared.
  • The legal structure could be changed later to partnership, LLC, or corporation easily, if there is a need.

Cons:

  • The owner is usually overworked because he/she must always be present in the business premises.
  • The owner could be sued, and personal properties confiscated to cover business debts.
  • The expansion and retention of high calibre employees is limited.
  • The owner is limited on the sources of capital that he/she could access.
  • The life of the business is limited to the life of the owner.
  • The owner is taxed on his income singularly.

Limited Liability Company (LLC)

A limited liability company (LLC) is a form of business that offers limited liability to its owners and this structure is defined in the US. Therefore, the owners of the business are seen as a separate legal entity while the company is seen as another separate legal entity. 

Pros:

  • The LLC does not limit the number of members or owners, that is, members could form from one to unlimited members.
  • The business could be taxed as either a C corporation, S corporation, partnership, and sole proprietorship.
  • The LLC could choose a flow-through income taxation method.
  • In most instances, the members have limited liability on their personal assets.
  • There is less paperwork in filing returns than a C corporation or S corporation.

Cons:

  • An LLC cannot issue shares to raise capital like a corporation.
  • Some states impose additional taxes on LLCs.
  • Some states (Arizona, Nebraska, New York) also impose high publication fees to create your LLC.
  • Unlike with a corporation, some banks may require members of an LLC to personally guarantee a business loan.

Should I switch from a sole proprietorship to an LLC?

Sole proprietorship is simple and easy to run, but it has a major disadvantage because creditors could take up your property legally if the business goes bankrupt. Another issue is the low ability of the sole proprietorship in acquiring more capital. An LLC could easily attract more investors compared to the sole proprietorship. 

Consequently, if you need to get additional capital, then it is better to switch to an LLC. More so, the tax method could be easily adapted to the method preferred by the owners. The LLC business could be taxed like a sole proprietorship, partnership, C corporation, and S corporation. Lastly, it is possible to choose the flow-through income taxation where members report the profits or losses on their personal income.

How to change from sole proprietorship to LLC

The requirements to change from a sole proprietor to LLC may change depending on the state you are operating in. Therefore, it would be best to seek professional help along with doing your own research to make sure you do not make any mistakes when transferring your business structure. With that being said, the common steps to change from a sole proprietorship to an LLC are as follows:

  1. Choose a name with ‘Limited Liability Company’ or LLC.
  2. Choose a registered agent and it could be anyone including yourself.
  3. You should file the articles of organization with the pertinent information.
  4. Either stick with the IRS classification or use Form 8832 to change options of how the LLC should be treated, such as a corporation, partnership, or disregarded entity.
  5. Apply for a business license according to the rules of the local government, industry, and state.
  6. Inform the insurance company on the changes in structure.
  7. Inform the bank with the new details to either update the old account or open a new bank account to a business bank account to make your bookkeeping separate and protected from personal liability. 

Note: there are online services that could guide you through the whole process and the services are relatively inexpensive.

Frequently asked questions

Are you still feeling a little lost about switching from your existing business as sole proprietor to either a single-member LLC or multi-member LLC? No need to worry. We’ve put together some of the most frequently asked questions about changing from a sole proprietor to LLC so you can feel more informed before making any decisions about changing your small business structure. 

Which name should I choose for my LLC?

There are not many legal requirements in choosing an LLC name for your new LLC. The main issue is that the name must be unique. In addition, because you are most likely doing business as (DBA) under your legal name, you want your new business name to stand out, yet relate to the type of business you are offering. Therefore, your business name should not be the same as any other business entity or a trademark phrase. The name should not intend to mislead by including restricted names, such as Limited Partnership and Corporation. 

In addition, there are also other prohibited names, such as City, Bank, Federal, Insurer, and Township, because they could indicate a different meaning. Other than the legal requirements, you are free to come up with a name that suits your needs considering questions, such as originality, meaningfulness, domain ready, social media presence, and memorability.

How do I fill in the articles of organization of an LLC?

There are five easy steps to fill in the LLC Articles of Organization. It is vital to note that once this document has been filled, the sole proprietorship will change to an LLC officially. Before filling an LLC, it is necessary to have identified a registered agent who is there to send and receive the articles of organization on behalf of the LLC. To file the LLC’s Articles of Organization, follow these steps:

  1. Start by visiting the state’s Secretary of State Website.
  2. Answer the five sections in the document.
  3. Provide a signature in the LLC.
  4. Pay a filing fee depending on the state’s directive.
  5. Submit the document electronically, send it to the Secretary of State Office, or file articles of organization in person.

What is Form 8832?

This form is vital because it identifies the wishes of the LLC in how it should be classified for taxation purposes. An LLC can be classified as an entity disregarded, a partnership, or a corporation. The IRS will receive the legal document and tax the LLC accordingly.

Do I need a TIN to get EIN?

Yes, you will need a TIN. The Tax Identification Number (TIN) is used by the IRS as a tracking number for all federal tax. It contains information on tax returns that have been filed with the IRS, just as you would when filing your self-employment taxes on your business and personal finances as a sole proprietor. 

What is flow-through income taxation?

In this situation, the business does not pay corporate tax. It is a method that avoids double taxation, where double taxation is a situation where the owner is taxed, and the business is taxed separately as a separate legal entity when your LLC goes to file taxes each year. Therefore, the individual owners will be taxed at the tax rate for ordinary income.

Can an LLC be converted back to sole proprietorship?

Yes, it is possible to convert the LLC back to a sole proprietorship. However, the legal procedure is cumbersome with processes requiring the notification of creditors, filing or tax forms, publishing resolution, and transferring licences.

Is the conversion process from sole proprietorship to LLC standard

No, the conversion process differs from state to state. However, the major procedure is similar with several standard documents being filed by each LLC. Nonetheless, each state dictates the process, and it would be necessary to follow the guidelines of your state.

Can I change my EIN from a sole proprietorship to an LLC?

Yes, you can change the EIN from a sole proprietorship to an LLC. The Employer Identification Number (EIN) is a number issued by the IRS for tax purposes only. It is vital to note that each party is limited to one EIN. Therefore, it cannot be shared. More so, the rules of changing an EIN for a sole proprietorship say that a person should acquire a new EIN if they incorporate for liability protection as it will keep your personal and business finances separate. In short, you should change your Ein from a sole proprietorship to an LLC. The main reason is that the IRS will look at the sole proprietorship business as a separate business from the LLC that has been newly formed.

Can I convert my sole proprietorship to a corporation?

Yes, you can change your existing business from a sole proprietorship to a corporation. It’s usually best to change from sole proprietorship to corporation when your business has experienced growth. As a corporation, you will have the advantage of increased financing through shares, long term loans, and other forms of financing. 

In addition, you will have limited liability because creditors can only sue the company for any due credit sums. The sole proprietorship is not a legal entity and the owner’s assets are given as compensation for the business’s legal obligations. However, for a corporation, the owner is protected from such actions. In the process of changing, documentation is vital as many assets will need to be transferred at fair market value. Most of the business is usually transferred tax-free from a sole proprietorship to a corporation according to the Income Tax Act.

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