How to Change a Sole Proprietorship to an LLC?

Changing your company from a sole proprietorship to an LLC (limited liability company) can be intimidating at first. However, as your business grows and you require a greater level of legal separation between your personal and business affairs, this is something you’ll need to address.

In this article, we’ll walk you through the steps and assist you in transitioning your company from a sole proprietorship to an LLC.

The pros and cons of each business structure

If you started your business on the side while working full-time, or if you did freelance work that didn’t require much liability protection, a sole proprietorship was probably the best option for you.

However, as a company grows, so does the need to keep your personal and business finances and affairs separate. Transitioning to an LLC is a common next step because an LLC can limit your personal liability if your company is ever sued for a large sum of money.

Let’s take a look at how the two business structures differ before we get into the process of changing from sole proprietorship to an LLC.

Sole proprietorship

For sole proprietors, there are few (if any) ongoing requirements.
When you are a sole proprietor, you are not required by law to separate your business and personal assets; however, we recommend that you avoid combining your business and personal finances.
You are not required to pay unemployment tax on your own income, but you must if you have an employee.
The disadvantage is that sole proprietors are subject to unlimited liability for losses, debts, and liabilities, which means that if you were sued, for example, your personal assets could be used to cover the payments.

Limited Liability Company (LLC)

If the company is sued or incurs debts, the members’ assets are usually protected.
As an LLC, there can be no mixing of business and personal assets. Members are no longer protected by limited liability if assets are mixed (this is referred to as piercing the corporate veil).
Most states will charge franchise fees and taxes to LLCs. Because these vary by location and are charged in addition to state and federal income taxes, converting to an LLC is not a guarantee that your tax bill will be reduced.

How to transition a sole proprietorship to an LLC

It will take some time to change your company’s legal structure from a sole proprietorship to an LLC limited liability company.

When you’re ready to begin, pin this checklist to your wall and work your way through each of the steps on the list.

1.Consider professional assistance

Creating an LLC has a lot of moving parts, so you might want to hire someone to help you. If you do need assistance, you can sign up for online legal services or hire an attorney. An online service will walk you through the setup process and is the less expensive option. Hiring an attorney, on the other hand, will provide you with more specialized assistance, but it will be more expensive.

2.Choose a name for your LLC

While the requirements for LLC names differ by state, all states require that the business name reflect the LLC status. Select a name that includes the phrase “Limited Liability Company” or an abbreviation of it (LLC).

3.Designate a registered agent

Your registered agent will serve as the LLC’s primary point of contact with the state and other legal authorities. You have the option of acting as your own agent, or your attorney can do so.

4.File the articles of organization

The articles of incorporation are a document that contains important information about your LLC (business name, address, registered agent, the names of members, etc.).

5.Register with the IRS

An LLC can be taxed as a corporation, partnership, or disregarded entity (income is reported on the owner’s individual tax return). You can either stick with the default IRS classification or use Form 8832 to select a different option.

6.Re-apply for licenses for your new LLC structure

Business license regulations differ by state, industry, and locality. The Small Business Association Licenses and Permits Tool can assist you in determining what licenses and permits you require.

7.Talk to your insurance company

You’ll need to contact your insurance provider and inform them that your company’s structure is changing. They can also advise you on whether you need to purchase new commercial insurance.

8.Update your bank information or open a new account

In many cases, you’ll need to open a new business bank account for the LLC, but you’ll also need to update your business bank information to reflect your new LLC status. If you open a new account, make sure to close the old one as well (after all checks and purchases have gone through). Stop using the account and change the banking information for any automatic payments you make while you wait for those payments to clear. Also, notify clients of your new company name so that they can make payments to your LLC.

9.Get a New EIN or ‘Transfer Existing EIN

Get an EIN

The US Internal Revenue Service (IRS) uses an Employer Identification Number (EIN) to identify and tax businesses. It is essentially a business’s equivalent of a Social Security number.

When you apply directly with the IRS, EINs are free.

Transfer an EIN

According to the IRS, sole proprietors who incorporate (in IRS parlance, form an LLC or corporation) must obtain a new EIN. When you apply directly with the IRS, EINs are free.