How to Turn a Sole Proprietorship into an LLC: Everything to Know
Before switching to an LLC, sole proprietors should understand the requirements and consequences of such a move.3 min read
How to turn a sole proprietorship into an LLC is a question that many sole proprietors contemplate when they wish to expand their businesses or gain protection from personal liability for business debts. A limited liability company (LLC) is a hybrid business entity that is popular among startups and fast-growing businesses because it offers the liability protection of a corporation and the tax advantages of a sole proprietorship or partnership. Before switching to an LLC, sole proprietors should understand the requirements and consequences of such a move.
What Is a Sole Proprietorship?
A sole proprietorship is a business structure wherein the business and owners are a single entity. It has only one owner and passes its income taxes through to its owner instead of paying them at the company level. Since it is a simple business structure, a sole proprietor requires minimal paperwork, simple filing of tax returns, and compliance to fewer regulations. It also enables the owner to gain all of its profits. However, it makes its owner personally liable for all its debts, lawsuits, and other financial obligations.
What Is an LLC?
Unlike a sole proprietorship, an LLC ensures that the personal assets of its owners will not be seized in the event of a lawsuit or debt collection action. In many states, an LLC's owners, who are also called members, are able to receive distributions of the company's profits without having to pay taxes at the company level. The members also enjoy greater flexibility in profit distribution compared to a corporation.
How to Convert a Sole Proprietorship to an LLC
The process of establishing an LLC may vary from one state to another, but it generally involves the following procedures and requirements:
Name Your LLC
The first step to changing your sole proprietorship to an LLC is choosing a business name. If the current name of your business is already taken by another registered LLC in your state, you need to change your business name to something unique. To make sure that your business name is available, you can contact the office of the Secretary of State. Many states have databases of registered business names on their websites.
If the name you chose is available, you have to make sure that it does not violate someone else's trademark. You can do this by using the trademark database on the U.S. Patent and Trademark Office's website. In addition, you are required to include “Limited Liability Company,” “Liability Co.,” “LLC,” or an equivalent term or abbreviation in your business name.
File the Articles of Organization
Next, you need to file the Articles of Organization with the Secretary of State or the appropriate state agency. When completing this document, you are required to include the following information:
- Name of your LLC
- Address of your LLC
- Purpose of your LLC
- Name and address of your registered agent
- Whether your LLC will be member-managed or manager-managed
Draft an Operating Agreement
In some states, you are required to submit an operating agreement when filing for LLC status. This document includes information such as:
- Each member's ownership percentage
- Voting rights of each member
- Profit distribution method
- Measures to be taken when someone leaves the business
Even if an operating agreement is not required in your state, it is a good idea to create one.
Obtain an Employer Identification Number (EIN)
Even if you already have an EIN as a sole proprietor, you will most likely have to apply for a new one when forming an LLC. The EIN is used for handling payroll, filing taxes, opening a business bank account, and securing business credit.
Get a New Business Bank Account
It is necessary to open a new business bank account for your LLC even if you already have one for your sole proprietorship. A new business bank account allows you keep your personal and business finances separate, so that you can protect your personal assets and streamline the process of recording tax reporting.
Get the Necessary Business Licenses and Permits
You may also need licenses or permits to operate your LLC legally, such as a professional license, health department permit, or a reseller's permit. You can contact your local or state government to find out about the licenses or permits you need to obtain.
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