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