Sole Proprietorship Vs Llc: Whats The Difference
It can be hard to know if changing from a sole proprietorship to an LLC is right. Take a look at these key points on each business structure to help you decide.
Sole proprietorships are
- Easy and affordable to form
- Considered the same legal entity as the owner
With a sole proprietorship, you are personally responsible for all business losses, debts, and liabilities.
Limited liability companies are
- Owned by one person or more
- Moderately easy and affordable to form
- Considered different legal entities than the owners
LLCs combine aspects of corporations and partnerships. An LLC separates business and personal liabilities, so your assets are protected and owners not liable for business debts. There is also a shared tax responsibility between members, like a partnership.
Pros And Cons Of Incorporating A Sole Proprietorship
In a sole proprietorship, only one person owns the company. The owner doesn’t pay corporate taxes on any profit but instead reports it on their personal income tax return. Some advantages of this business type include fewer regulations, less paperwork, simpler tax returns, and one profit beneficiary.
There are many advantages of incorporating a sole proprietorship besides separating your personal assets from your business, including:
- Your personal assets are not at risk if there is a company lawsuit or bankruptcy. Note that you may want to consider business liability insurance because there are some cases in which you might be liable.
- Corporations offer tax savings, which varies depending on the profits your corporation is realizing.
Potential Benefits Of Changing To An Llc
So, whats wrong with operating as a sole proprietorship? Well, possibly nothing but it depends on the situation. No entity type is ideal for every business!
There is no legal or financial separation between the business owner and the company in a sole proprietorship. Therefore, if someone sues the business or the company runs into money troubles, the owner is personally responsible for any legal claims and debts. That puts the owners home, cars, bank accounts, retirement savings, and much more at risk of being taken to settle those obligations.
By forming an LLC, business owners can help protect their personal assets and property. An LLC is a separate legal entity from its owners. So, under most circumstances, an LLCs owner is not personally liable for the legal and financial debts of the business.
Also, an LLC provides tax flexibility. By default, an LLC is taxed the same as a sole proprietorship, with all profits and losses flowing through to the owners individual income tax returns. However, LLCs that meet the IRSs eligibility requirements may elect to be taxed as an S Corporation to help alleviate some of the self-employment tax burdens on their members.
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Get Business Licenses And Permits
You need to register new business licenses and permits for your LLC. Check with your state to find out which licenses and permits apply to your business. Licenses you might need include a business license, sellers permit, and zoning permit.
You must apply for a new Employer Identification Number with the IRS. This is true even if you already have an EIN for your sole proprietorship.
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How To Change A Sole Proprietorship To A Partnership When One Partner Is In A Different State
Converting a sole proprietorship to a partnership is a simple process. If you’ve been operating your business as a sole proprietor and are now looking to bring on a partner, you can quickly alter your business structure.
When considering a change in your business structure, a question many people have centers around the physical location of the partners. General partnerships do not require the partners to reside in the same state. As a result, your partnership may exist in any state, though there are other things to consider.
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Filing Taxes As A Partnership
As a business, a partnership does not pay income tax.
A partnership is also a pass-through entity: profits and losses are passed through to the partners, who are responsible for including their share of the income on their personal tax return. However, partnerships do need to file an annual information return to report income, deductions, gains, and losses for the business.
Why Change Your Business Type
As a business grows, things change. Here are some reasons a business might decide to make a change:
Liability Protection: Many small businesses begin as sole proprietors and decide at some point to lessen their personal liability by forming a business entity which can offer some liability protection, such as an LLC or a corporation.
Tax considerations: Most often, businesses change legal type for tax reasons. The most common change, for this reason, is from a pass-through entity to a corporation. A pass-through entity is a form of business in which the business doesn’t pay income tax. The owners of the business pay the taxes through their personal tax returns. These entities sole proprietorship, partnership, S corporation, and limited liability company must pay taxes on the total net income of the business each year.
A corporation may retain some of its income , which lowers the business tax bill.
Employees: If you have employees, it increases your business liability and complexity, and you might want to consider going to a business type that provides you with more liability protection.
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Pros And Cons Of Corporations
A corporation is a business entity that is legally separate from its owners. It has the right to enter into contracts, take legal action against others, give and receive loans, own assets, hire workers and pay taxes.
One of the most significant things about a corporation is its limited liability. That is, shareholders have the right to participate in the profits through stocks and paid dividends, but are not held personally accountable for the company’s debts or legal issues that may arise.
Remember that famous trial where the woman successfully sued McDonalds for serving their coffee at too high a temperature? Good thing McDonalds was incorporated!
|The Pros||The Cons|
Owners are separate from legal liability so theyre not entirely responsible when faced with legal issues or debt.
The process is time consuming and expensive, lots of paperwork.
Ability to sell stock, which raises the likelihood of acquiring financial capital.
Tons of regulations, which make for very little flexibility.
Well established structure with clearly defined roles, accountabilities and agendas.
Possibility of double taxation .
Employees have the option to buy stock at a fixed-in price, and receive stock benefits.
Sole Proprietorship: An Overview
If you want to begin operating a sole proprietorship, you can simply begin doing business without filing any paperwork or paying any fees. All states recognize such business entities, and indicate that once you begin offering your products or services to the public, you are said to be operating a sole proprietorship.
As previously noted, however, the sole proprietorship can only involve one person. Therefore, you cannot bring in any other partners or employees. Once this occurs, you must formally register as some other type of legal business structure, whether it is a corporation, partnership, or limited liability company .
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Restructuring Might Provide Tax Flexibility
The main reason that a business might change its structure from a sole proprietorship or partnership to an LLC or corporation is that it requires greater tax flexibility. Increased profits, expanding the workforce, and providing fringe benefits are indications of an expanding business.
Unlike sole proprietorships and partnerships, corporations offer different tax advantages that enable individuals to deduct certain items from their tax liability that they could not as an owner of a sole proprietorship. Whether it is increased protection of personal assets or reducing personal tax liability, restructuring a sole proprietorship or partnership into an LLC or corporation makes good business sense if the company has grown beyond the protections of its original structure.
Company Growth Is The Most Important Consideration
The primary consideration for changing a business structure is determining whether it has outgrown the benefits of its original structure. For instance, if a standard delivery service began as a sole proprietorship or a partnership and then moved on to deliver dangerous or hazardous material, changing that business structure to a limited liability company or corporation would provide greater personal asset protection for the owners. Business owners should consider any potential liability their company faces and whether or not that liability can be transferred to their personal assets. If so, a possible restructure might be in order.
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Incorporating A Sole Proprietorship
Changing from a sole proprietorship to a corporation helps protect the business owner’s personal assets by separating them from those of the business. The level of protection varies depending on the type of corporation you select.
- S corporations are often used for small businesses and aren’t usually taxed at the corporate level but rather on dividends.
- C corporations require you to pay corporate taxes, but you can also appoint a board of directors and issue company stock.
- Limited liability companies provide similar protection of personal assets, but owners can receive their company profits without paying corporate taxes in some states. An LLC also allows for greater flexibility for profit distribution.
Sole Proprietorship: Items Of Consideration Regarding Spouses
If you do intend to form a sole proprietorship, you should keep in mind the following considerations:
Since the IRS will not recognize your business as a sole proprietorship if you have more than one owner, you will want to ensure that you file your taxes properly by not indicating that you own the company with anyone else. However, if you file a joint tax return with your significant other, and that joint return includes the businesss profits, you wont be considered a partnership. When filling out your tax form, you will include the profits on Schedule C.
If you want to have your spouse do volunteer work for your sole proprietorship, you will have to be careful as to what you have your spouse do and how many hours he or she works for the business. If your significant other has any involvement in your marketing materials or signing of contracts, as the IRS might deem your spouse a partner in the business, and thus convert your sole proprietorship to a partnership. If this does happen, you will be faced with penalties and other tax implications.
Another item of consideration is equal ownership. If you want to equally own a sole proprietorship with your spouse, then you will automatically be converted to a partnership. This means that you will be taxed differently, and you will likely be forced to file formal paperwork and pay applicable fees associated with forming a partnership.
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Other Points To Remember
Incorporating your business is an exciting step, but the process can become complicated. It is particularly important that you properly document each phase of the process. Therefore, it’s recommended that you consult an attorney to help you with closing the sole proprietorship and creating the corporation.
Some other points to remember for your new corporation include:
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Procedure For Conversion Of Sole Proprietorship To Partnership
Drafting of Partnership Deed: The first step in converting a sole proprietorship into a partnership is the drafting of the firms partnership.
The deed for declaring transfer is different from a regular partnership deed. It will make several references to the proprietorship business and will declare the transfer to a partnership firm.
Important Inclusions: There are few mandatory inclusions in deeds such as date of sole proprietorship formation, proprietors name, business type and other details, like Service Tax registration and VAT. In this case, the TIN and Service Tax number must be disclosed.
Name: The partners are eligible to choose any name for their partnership firm. The government has no pre-enforced set of rules for naming the firm. The only thing is to keep in mind that the name given must not resemble a name of another business and it must not indicate any relations to the central or state government body.
Date of Starting: The deed must include the partnership starting or induction date. I.e, partners induction details.
Mutual agency between partners: According to this each partner will be bound by the actions of the other partners. Hence, with a mutual agency the partners act as the agents or the principals of the other partners.
Investment Details: The deed must state how much capital will each partner invests, how the profits and losses are split and what happens after retirement to one or more partners.
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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 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.
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
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Transfer Of Balance In Electronic Cash Ledger
There is no provision under the GST Act to transfer balance in electronic cash ledger from one entity to another entity. Hence, the taxpayer has to file the Form RFD-01 with a refund type of either Refund of Excess Balance in Electronic Cash Ledger or Refund on Account of Any Other Reasons to get the refund of balance in electronic cash ledger.
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.
Process Of Conversion Of Proprietorship To Partnership
The conversion of a sole proprietorship into a partnership begins with the drafting of the partnership deed of your firm.
The deed, in this case, would be different from a regular partnership deed, as it would also make several references to the proprietorship business and declare that it has been transferred to the partnership firm.
The details that would need to be included are the date of formation of the sole proprietorship, the name of the proprietor, the type of business and any other details, such as VAT and Service Tax registration, in which case the TIN and Service Tax number would need to be disclosed.
The deed would also include the date when you would be starting the partnership and induction of partner/partners into the firm.
The deed must state how much capital will be invested by each partner, how profits and losses will be split and state specifically what will happen in case of the retirement of a partner for whatever reason.
The deed must also state all the changes that will occur on account of the introduction of the new business partners. Even a change in the registration address of the firm should be included.
Registration is not a mandatory procedure. However, it is recommended, in certain cases, for the firm to register the deed. This enables the partnership to file suit and the partners to file suit against other partners.