Can a sole proprietor company be an LLC? The short answer is yes. As a small business owner, you know your company has fluid needs. If you’re a sole proprietor considering expansion, you might consider changing how your business is structured.
Let’s review the advantages of changing your structure, and then break down the 7 steps guiding you on how to change from a sole proprietorship to an LLC.
Advantages of Changing from a Sole Proprietorship to an LLC
- Less Personal Risk: As a sole proprietor, your personal assets and finances are at an increased threat because they’re not distinguishable from your business. If your business is sued, the plaintiff could be entitled to your money. In an LLC, however, the company is treated as a separate entity from you and will shield you from personal liability.
- Better for Business Growth: As your business expands, you take on more clients. Depending on your industry, some may require your company to have certain liability protections before they work with you. You can also add owners or, in an LLC’s case, members, to the team to help run your company.
- Flexibility in Tax Classification: When you convert from a sole proprietorship to an LLC, you can choose whether the company is taxed as a partnership or a corporation.
1. Name Your LLC
You might be thinking “I already have a name for my business, why do I need another one?” However, when you “convert” your sole proprietorship to an LLC, you’re actually creating a new company. A sole proprietorship runs as a single entity with you, the business owner. An LLC, however, is legally a separate type of business entity and therefore must be made from scratch.
Don’t worry! This doesn’t mean everything you accomplished as a sole proprietor is thrown away. At this step, simply select a business name, and make sure it’s available in your state and file it with the appropriate office.
2. File Your LLC With the State
Unlike sole proprietorships, LLCs require different forms to be supplied to the appropriate federal agency. When you turn a sole proprietorship into an LLC, you first need to submit what is usually referred to as the “Articles of Incorporation” with the state where you do business. Guidelines vary by state, but there are a few things they’ll likely need:
- Basic company info (name, address, etc.)
- The name and address of the registered agent of your company, who will receive and handle all documents related to the state
- The general purpose of your LLC
- The management structure of your company
3. Create an LLC Operating Agreement
The next step to transfer your sole proprietorship to an LLC is to create and file an operating agreement. LLCs must have this document in place to outline different parts of the business and how it will be run. The contents of an operating agreement change depending on your industry and ownership, but there are generally 6 key factors to include:
How the business was created and how ownership stakes and power are structured among all members of the company.
How the business is managed. How organizational changes are made and, if applicable, which members hold the power to do so.
- Capital/ Funding
An outline of how money was raised to fund the business and how that might translate to power within the company. Some companies also draw up how they will raise funding through investments and loans and how that can change the company structure.
- Asset Distribution
This section provides a structure of how members will divide and share financial and physical assets.
Contingencies put in place to follow when adding or subtracting a member from the LLC. This can be important to consider if you plan to bring on multiple members as your business grows.
You want to determine the circumstances that would necessitate it and what will happen in case the company dissolves. The allocation of assets and settlement of any outstanding debts can be included in this section.
Although some states do not require an operating agreement, it’s important to have one in place to make sure your company has a set structure in which it will run.
4. Register Your LLC With the IRS
One of the main reasons you might decide to change your sole proprietorship to an LLC is the flexibility it provides for taxation. LLCs can be “pass-through” business entities like sole proprietorships and partnerships that allow you to file business taxes on your personal return. You can also, however, elect to tax your company like a corporation, having the business’s taxes done separately from you and other members. Doing taxes this way can have advantages for you, including certain write-offs, deductions and lowered tax rates for eligible businesses.
Either way, you will need to register your new LLC with the IRS. The business will now be considered a separate entity from yourself, so you’ll have to apply for a new Employer Identification Number (EIN). Doing so will create a new entity for the IRS to acknowledge, and you can then select which tax classification is right for you.
5. Set Up Your LLC’s Bank Account
When you change from a sole proprietorship to an LLC, you need to separate yourself as an owner from the entity that is your business. Keep your personal finances clear from those your business generates. This is important for compliance purposes, as muddying the financial waters between you and your small business can void the liability protections that made you convert from a sole proprietorship to an LLC in the first place.
If you had a business account for your sole proprietorship, you will need to close that and apply for a bank account for the new company using your new EIN. Doing so will help protect your personal finances and assets in case the business incurs debt or is sued. Banks can have different fees for business accounts, so make sure to shop around to find something suitable for you.
6. Make Your LLC Compliant
Depending on your state, switching your sole proprietorship to an LLC can bring a whole new set of rules and regulations. These rules range from licensing policies to the way your company is run. Failure to comply could leave you and your business open to penalties handed down by state or federal agencies.
This can mean a lot of bureaucratic red-tape for you. There might be new requirements for licensing and permits your business needs. Some states even require companies to reapply when changing what type of business entity they’re run as, so check in with your county or state office to find out what you need to do to stay up to date.
Look into any other regulations your state may have for LLCs. They can provide rules for your company’s record keeping, meeting requirements and other operational and reporting procedures..
7. Tie Up Loose Ends With Your Sole Proprietorship
Once your new LLC is approved, it’s time to wrap up all business with the sole proprietorship. If you don’t, you might run into problems if any work you’re doing with the LLC gets tangled up with what remains of the old business.
If applicable, cancel your old “doing business as” name (DBA) with the same government office you had originally filed it. Close all old bank accounts, convert any files or invoices and make sure everything you do from now on is under the umbrella of your brand new LLC. Failure to do so could diminish all liability protections you sought when you decided to change a sole proprietorship to an LLC, and it could get you into legal trouble with local government.