Form An Limited Liability Company
First and most important step is to form a LLC. You can either do this yourself or hire an online company such as Rocket Lawyer to set this up for you. Rocket Lawyer offers a free trial and free incorporation if you use their service. So you definitely want to consider using them. We have a detailed review for Rocket Lawyer vs Legal zoom that will help you as well. You will need the following to make sure everything is done properly.
- File for Articles of Organization with Secretary of State
- Membership Agreement
How Hard Is It To Change From Sole Proprietorship To An Llc
Generally speaking, changing from a sole proprietorship to an LLC is nothing different from starting the LLC from scratch. You will have to file the same paperwork as someone who is having their first attempt at running the business.
The only difference is that, depending on the state that you are in, you may have to close your old sole proprietorships and the associated business bank accounts. If you don’t, there will be confusion, as you will be personally liable for two businesses – one of which is no longer in use. This action may take some extra time from your hands.
How To Change Your Sole Proprietorship To An Llc: 6 Easy Steps
Many small businesses get their start as a sole proprietorship. After all, its the default business structure. If youre a single business owner and never filed any official formation paperwork with the state, then youre operating as a sole proprietorship.
There comes a time when a sole proprietor wants to formalize the business. Perhaps you realized that your side hobby is now a legitimate and blossoming business. Perhaps you realized that operating as a sole proprietorship puts your personal savings and assets at risk should your business incur any debt or be sued. Or maybe you want to take on a new client who requires you to operate as an LLC or corporation.
No matter the reason, the bottom line is its affordable and relatively simple to create a Limited Liability Company . And, there wont be many changes in the way you operate your business. On the plus side, the LLC puts separation between your business and your personal assets and youll have more flexibility in how your business is taxed. You may even change your perception of your business and feel more motivation to see it grow.
If youre interested in forming an LLC, heres the general process. Note that specifics will vary by state, but these six steps will give you a general idea of what to expect.
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When To Change From A Sole Proprietor To An Llc
It’s time to make the switch to an LLC when you are ready to earn a profit and grow your business. This is because sole proprietorships are only good for very low-profit/low-risk businesses.
Forming an LLC allows owners to take on risk and grow their business.
- Increase peace of mind
- Protect your savings, car, and house
- Protect your privacy
- Allow for greater profit
What Is An Incorporated Company
If your business is continually growing in size and profitability, then it may be time to register it as a company on a federal or provincial level, otherwise known as incorporation. Most financial experts recommend this process for businesses that earn $50,000 or more yearly.
While some business owners are hesitant about the extra costs and documents associated with the registration process, incorporating can be highly advantageous because it turns your private enterprise into a separate legal and financial entity. This provides you and any other shareholders added with protection from lawsuits, debt collection penalties, and other liabilities that the corporation accrues. Not to mention, it allows your company name and legacy to live on, even after you have sold your shares or deceased.
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Why Would A Business Choose To Change From A Sole Proprietorship To An Llc
The primary benefit of converting your sole proprietorship to an LLC is liability protection. An LLC gives you an added corporate shield layer of legal protection that can keep your business and personal funds separate, which means your personal assets such as your home, your car and your retirement savings will be protected in case of a lawsuit against your business.
Some other reasons to transition from a sole proprietorship to an LLC include enhancing your business credibility and branding. Some customers might feel that doing business with a registered LLC is more reputable than buying from an unregistered sole proprietorship. With legal rights to the business name, you can advertise and commit to creating your brand.
Is It Time To Convert Your Sole Proprietorship To A Corporation Or Llc
One of the biggest issues a small business owner must face is whether to incorporate and if so, when.
Many people start their businesses as sole proprietors. Often, it is because they aren’t really planning their business and just started selling a product or service. Sometimes, they don’t want to go to the effort or cost of incorporating until they know if the business is viable. Other times, they don’t feel their business is risky enough to need protection.
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Pay The Annual Franchise Tax
To do business in California, an LLC must pay an $800 franchise tax fee. This fee must be paid regardless of whether the business makes any income and is due every year.
If your LLC’s annual gross revenues exceed $250,000, an additional annual fee is also required.
There is an exemption for LLCs formed in California in 2021, 2022, or 2023. Under the new legislation, an LLC that registers or organizes to do business in California is exempt from the state’s $800 minimum annual franchise tax for its first taxable year. In the second taxable year, the LLC must pay the $800 fee.
How To Change From Sole Proprietorship To Llc
Home » Blog » How to Change from Sole Proprietorship to LLC
There comes a time in many a sole proprietors life when they need to formalize their business.
Often its because their side-hustle has grown into a booming full-time business.
And now they , liability protection, funding options, or any of the other advantages an LLC provides.
If thats you and youre wondering if you can and should change to a limited liability company , the answer is yes.
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What Can A Sole Proprietorship Sell Or Transfer
Since a sole proprietorship represents the owner of the business, you cannot actually transfer a sole proprietorship to someone else. All the legal obligations and debts that youve undertaken throughout the operation of the business will remain with you and cannot be transferred to someone else. However, you are able to sell and transfer the assets of the business to a new owner. These can be tangible assets, intangible assets, or both. But before the new owner can acquire these assets, they must set up their own unique business structure first. This could be a sole proprietorship of their own or another business entity type, like a Limited Liability Company. Once they have created their own business structure, the sales transaction for the assets can begin.
Remember that tangible assets refer to all physical assets, such as inventory, supplies, land, buildings, and machinery. Intangible assets refer to intellectual properties that are not physical such as trademarks, patents, copyrights, and brand names. It is up to you to decide which of these assets you want to sell. But if youre looking to sell your business and you want to set the highest asking price possible, then youll want to include all the assets you have for the business so that it looks more attractive to potential buyers.
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Open A New Bank Business Account
Youll also need to open a new bank account for your LLC to maintain separation between your personal and business finances.
Not only will this ensure you dont pierce the corporate veil, risking losing your limited liability, it also helps you streamline your business accounts, which reduces your tax reporting costs.
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Llc Vs Sole Proprietorship: Taxes
A single-member LLC and a sole proprietorship resemble each other in terms of tax treatment. Both are pass-through entities, which means that the business itself doesnt pay income taxes. The owner reports business income on a Schedule C thats attached to their personal tax return, and the income gets taxed at the owners personal income tax rate.
Multi-member LLCs are also pass-through entities, with each owner reporting and paying taxes on their share of the businesss income. The only difference is that a multi-member LLC must file a business tax return with the IRS, Form 1065, U.S. Return of Partnership Income. In addition, each member must attach a Schedule K-1 to their personal tax return, which shows their share of the businesss income.
In addition to income taxes, both LLCs and sole proprietorships might have additional tax responsibilities. No matter which business structure you adopt, youll need to pay payroll taxes if you have employees. Youll also need to collect state and local sales taxes if you sell taxable goods or services. And finally, as a self-employed business owner, youre responsible for paying self-employment taxes to the IRS. These taxes cover your social security and Medicare tax obligations.
A few states and local jurisdictions levy additional taxes on LLCs. Depending on the state, this might be called a franchise tax, LLC tax, or business tax. Youll also have to pay state and local income taxes and payroll taxes.
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Taxes For A Sole Proprietorship Vs Llc
With both an LLC and a sole proprietorship, the profit of the business passes through to the owners personal tax return. But LLCs have more flexibility in how they are taxed, which may result in tax savings.
Sole proprietors typically report their business income and expenses on Schedule C. This form is filed with the owners personal tax return. The net profit from the business indicates the net profit of the business and it passes through to the owners personal tax return.
Pass through entities like LLCs and sole proprietorships may benefit from the Qualified Business Income deduction that allows them to deduct 20% of QBI. Not all business income qualify, so talk with a tax professional.
Single-member LLCs are automatically treated as sole proprietors for tax purposes, but may elect to be taxed as an S Corporation or C Corporation. This may provide tax savings but will also carry additional requirements. Check with your tax professional to choose the right filing status for your business.
Dont forget about self-employment tax! The current self-employment tax rate is 15.3%. Normally this is split between the employer and the employee, but when you are the employer you pay the full amount yourself.
What Do You Need To Incorporate Your Business
When you incorporate, it may be wise to hire a professional accountant to oversee the financial side of the registration process, as well as a lawyer to counsel you on any legal requirements. In that case, save at least $1,000 $2,000 for these costs alone.
You may also have to provide these documents during and in the years that follow the registration process :
- Articles of incorporation
- Yearly information returns
- Various corporate records
- Annual corporate tax returns and financial statements
- Payroll remittances and filings for corporate employees
- GST and/or HST filings
- At least one NUANS or CIDREQ name search report to confirm that your company name is not already taken.
Although you can do all this online through the Government of Canada website, there are also many physical outlets and business web portals in every jurisdiction where you can register for provincial or federal incorporation.
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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 businesss 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 youll have to apply for a new Employer Identification Number . Doing so will create a new entity for the IRS to acknowledge, and you can then select which tax classification is right for you.
Llc Vs Sole Proprietorship: Legal Protection
In a sole proprietorship, theres no legal separation between the business and the owner. The owner is personally responsible for the businesss debts. If the business goes bankrupt, the sole proprietor has to file for personal bankruptcy, and both personal and business debts will be included in the bankruptcy proceedings. In addition, someone who sues a sole proprietorship can name the owner personally in the lawsuit and come after their personal assets.
One of the best ways to protect your personal assets is to form an LLC. Since an LLC is a legally separate entity from the owner, the owner isnt personally liable for the businesss obligations. If the business fails, the owners can file for business bankruptcy, and they dont have to pay business creditors out of their own pockets. And with some exceptions, someone who sues an LLC cant personally sue the owners. Of course, owners in an LLC can be held personally liable for fraud, negligence, or personally guaranteed debts. Theres no business structure that offers absolute protection for owners for liabilities connected to the business.
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Apply For Business Licenses And Permits
Dont forget about any of the licenses and permits that are required to legally run your business such as a professional license, resellers permit, or health department permit. Some states require that you reapply for a license when your business structure changes. You can contact your local office or a site like BusinessLicenses.com to find out about your specific licensing requirements.
Thats it. With those six basic steps, youve now formalized your business activities into a formal business structure.
If youre wondering what comes nextyou can opt to be taxed as an individual and still fill out the Schedule C and Schedule SE like you did as a sole proprietor. Or check with your CPA/tax advisor to see if theres a better tax strategy, since you now have more options as an LLC than you did as a sole prop.
Lastly, youll need to maintain your LLC, or you could end up losing your personal liability protection. Check to see what your states maintenance requirements are, as youll typically be required to file an Annual Report and pay a nominal fee.
Best of luck on your business venture, and congratulations on taking this important step toward creating a solid foundation for your new business.
Update Your Banking Information
In most cases, when you change a sole proprietorship to an LLC, you need to open a new bank account for the LLC. However, you will need to update the banking information related to your business at the very least. This is to ensure that the information reflects your LLC status.
If you open a new business account, make sure you close the old one. But before closing, go through the necessary information like all checks and business purchases.
While you might have to wait for the payments, stop using the previous account. Make the changes in the banking information for your automatic payments. Also, inform your clients about the new LLC status and the LLC name so that they can issue your payments.
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Llc Vs Sole Proprietorship: Paperwork And Compliance
The final difference between an LLC vs. sole proprietorship has to do with paperwork and compliance requirements. As we mentioned earlier, a sole proprietorship requires the least amount of paperwork prior to launch. After launch, a sole proprietor only needs to keep up with federal, state, and local taxes. In addition, a sole proprietor might need to renew business permits.
An LLC has more compliance responsibilities. After filing initial articles of organization, LLCs have to file an annual report in many states. An LLC with multiple members has even more responsibilities, such as drafting an operating agreement, issuing membership units, recording transfers of ownership, and holding member meetings. None of these steps are legally required, but are highly recommended for LLCs to preserve liability protection for members. In addition, since an LLC is a registered business entity, dissolving an LLC takes additional paperwork.
When Is A Verbal Agreement Legally Binding
For any contract to be binding, there are four major elements which need to be in place. The crucial elements of a contract are as follows:
Therefore, an oral agreement has legal validity if all of these elements are present. However, verbal contracts can be difficult to enforce in a court of law. In the next section, we take a look at how oral agreements hold up in court.
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