Change Sole Proprietorship to LLC: Everything You Need to Know
Wondering if you can change a sole proprietorship to an LLC? A sole proprietorship LLC, or limited liability corporation, is a company that uses a particular state legal formation to both provide liability protection and to reduce tax liability for its owner. 3 min read
Wondering if you can change a sole proprietorship to an LLC? A sole proprietorship LLC, or limited liability corporation, is a company that uses a particular state legal formation to both provide liability protection and to reduce tax liability for its owner. While there are other kinds of sole proprietorships, they have less protections built in for their owners in the event of catastrophic events. LLCs are used by many sole proprietors to give themselves a leg up on the competition and maximize profits.
Sole Proprietorships, Corporations, and LLCs
When considering what kind of company you want your business to be, you need to understand some key terms. There are three main kinds we will be looking at here:
- Sole proprietorships
- Corporations and S corporations
First, sole proprietorship. In a sole proprietorship, a single individual owns the business by themselves. Since there is only the one owner, the company's income counts as personal income and is included as such on their yearly filings. But the owner is fully liable for any debts incurred by the company through credit, legal proceedings, or any other legal means.
Corporations isolate their owners from such liability. A corporation is owned by people called shareholders who each own a percentage of the company. It's important to note that a corporation doesn't need to be owned by multiple people or entities; a single person can hold all the stocks.
Corporations count as individuals by law, and as such, are liable for their actions separately from their owners. But corporate earnings are usually double taxed, first as income to the corporation and then as investment income or salary to the owners receiving the money. S corporations, designed for smaller firms, are the exception, allowing income to “pass through” to the owners as long as the filing corporation meets stringent requirements.
LLCs have nothing to do with federal taxes and are not recognized by the IRS. Instead, an LLC is a business that files state taxes in a pass through manner, but assigns liability to a company rather than the owners. It is similar to a state version of the S Corporation in that way, though an LLC is not necessarily required to be a corporation and an S corporation cannot always qualify as an LLC. LLCs also offer more flexibility in distributing assets and simpler paperwork on tax filings.
Often when people start businesses, they will file as sole proprietors simply because they require the least amount of legal advice and complication. This can turn out to be a mistake in the long run; many business owners save time up front only to face existential legal threats within a short time.
One of the biggest problems faced by business owners is dealing with personal liability. Simple company organizations like sole proprietorships or partnerships leave the owners fully liable in the case of legal action, bankruptcy, or debt default. This is why corporations of various sorts are generally preferable for many operators, especially those in high-risk fields that might end up in legal action as a part of normal operations.
Converting to an LLC
When you designate your company as an LLC you create a new legal person, as discussed above about corporations. By law, this person has most of the rights of an actual human being, with the ability to own property, businesses, and financial accounts. Those dissatisfied with the actions of the LLC will have to seek legal relief from the company itself, and are limited on how much they can recover by the scope of the company's assets.
LLCs can have multiple owners, so when you convert your business, you can decide to bring in partners if you want. If not, it is perfectly fine to form a single-owner LLC. The laws governing its liability and taxation will function exactly the same.
Of course, forming an LLC is a more complex legal action than simply starting up a sole proprietorship. It will probably require consultation with a lawyer and an outlay for filing fees. Those leery to make such a change due to those costs should look at the relative long-term advantages to different formations before making a choice.
If you need help with reorganizing your sole proprietorship company as 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, Stripe, and Twilio.