Can you convert a sole proprietorship to an LLC is a common question business owners have. This is possible when the correct steps are taken.

What Is a Sole Proprietorship?

An individual and their business are one entity when the business is a sole proprietorship. Only one owner is allowed in a sole proprietorship. In this type of business entity, the person owns the business assets and is in charge of the registration and Employer Identification Number (EIN). There are many advantages to this, but a downside is being responsible for legal actions and lawsuits that could be potentially devastating.

There is less paperwork in a sole proprietorship, which many owners enjoy. There are also fewer regulations, and tax returns are more simple with a sole proprietorship. Many businesses that are on the smaller side start as a sole proprietorship. Single business owners who haven't filed any formation paperwork with their state are operating as a sole proprietorship. This type of business entity is affordable and easy to form.

It's not required by law to separate personal and business assets as a sole proprietor. However, it is recommended that personal and business finances aren't combined. Sole proprietors aren't required to pay unemployment tax on their income but will need to pay it if they have an employee.

What Is an LLC?

When creating a limited liability company, this forms a new person legally. That means the new person, or entity, is separate from the business owner. The same rights apply to the legal entity as it does for a person, including:

  • Can sell and buy property
  • Can own property 
  • Can operate and own a functioning business
  • Can own checking and savings accounts

Since the LLC is considered a separate person, they will take on any liability problems that arise. The LLC will be subject to legal penalties, obligations, and lawsuits. The business can be taxed in a different way when it switches from a sole proprietorship to an LLC. A new tax ID must be created to form an LLC, which must differ from the tax ID the sole proprietorship had. There can be multiple owners, or members, in an LLC.

When a firm becomes an LLC, the owners are called members. They can get the profits they're owed through the company without needing to pay corporate taxes. Profits will be distributed in a more flexible manner among the owners than they are in a corporate structure. Many owners perceive the business differently since there is a separation between them and the business. This might motivate them to work harder to make it grow.

LLCs combine different parts of partnerships and corporations. Personal and business assets may not be mixed in an LLC. If this occurs, the members won't have the protection of limited liability anymore.

Can You Change a Sole Proprietorship to an LLC?

Every state allows sole proprietorships to convert to LLCs. The Secretary of State is able to provide the correct forms to apply for this. The "corporate veil" must be maintained when converting to an LLC, meaning personal property needs to stay separate from the LLC's property.

Credit cards, bank accounts, and loans need to be kept separate so the LLC's bank account cannot be treated as a personal checking account. The owner is still in charge of their personal actions and taxes. For example, the protection an LLC offers won't help them avoid the business' tax issues, protect them from a crime they committed, or get out of paying loans that were personally guaranteed. 

Time limits apply to LLC taxes, correct transfer, state regulations, and certain filing requirements. The LLC needs to be compliant with all state regulations and requirements.

What Is a Corporation?

A corporation separates personal assets from business assets and makes the business a distinct entity. One or more people can own a corporation. If the business is small, an S corporation may want to be looked into. This type of business entity is specifically for small businesses. They usually only need to pay taxes on dividend earnings and not on corporate taxes.

If you need help with figuring out if you can convert a sole proprietorship to an LLC, you can post your legal need on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.