Many people that break into the world of business usually begin their careers as sole proprietors. The main reason is that most people usually start these businesses as hobbies or side jobs or mostly people prefer to work alone rather than as a team. This is also an easy structure for many people to work with as there is no need to register yourself with the state and get involved with other legal matters. But if you operate your business more regularly and keep making progress at a steady pace, there may come a time that you may feel the need to shift your business from sole proprietorship to Limited Liability Company or LLC. This may happen as your business has grown to the point where it has now become legitimate instead of just a hobby. Some people might also switch from entity to the other due to some client requests. Certain clients may require you to operate as an LLC or as a corporation. Another reason that people decide to shift from proprietorship to Limited Liability Company as it allows them to save their personal assets by separating them form their business assets. Although shifting form one entity to another may seem like a formidable task but it is rather easy and on the plus side doesn’t require you to make any major changes to how you operate your business.
What is a sole proprietor?
A sole proprietor is any individual who starts his own personal business and doesn’t register it with the IRS or the state as a corporation or limited liability company (LLC). Any revenue that you generate through this way will be considered your personal income by the IRS. As stated above, a sole proprietor has to report his business gains, expenses and losses through the schedule C IRS form along with 1040 from when filing taxes. These self-employment taxes also include social security and Medicare taxes. Usually self-employed individuals have to pay 15.3% of their net income as tax. If you register yourself as a corporation to the state, then you would have to file both personal and corporate tax returns essentially doubling the amount of taxes that you have to pay. Being a sole proprietor provides you the advantage of avoiding this. However, being a sole proprietor also means that you are personally responsible for any business debts that you may sustain. In case a sole proprietor fails in paying off the debt, his personal assets can be targeted by the creditors.
Steps involved in moving from sole proprietor to LLC
The process of changing from sole proprietor to LLC will take some time as you would have to make some changes to your business structure. The following steps are involved in changing your business to an LLC:
Choose your LLC name
The first thing you need to decide on is what will be the name of your LLC. This is necessary as you are now about to legitimize your business. It is important that you go over your state laws as different states could have different LLC name requirements. Thus, it is better to do your research beforehand before settling on a name. Also make sure that your LLC name is unique. If someone in your state is already operating an LLC with a similar name, then you are legally forbid to use that name. You can check if a name is taken or not by contacting your state’s secretary of state office. You can also use the services of an online legal filing service to do this job for you. There are also certain websites that offer these services free of cost.
File articles of organization
After you have decided on the name of your LLC, it is finally time to register your business with your state as an LLC. For this purpose, you would have to file paperwork known as articles of incorporation or organization. The documents involved will ask you some basic information regarding your LLC. This information includes name of your LLC, address of your LLC, the purpose of your LLC, name and address of your registered agent and how will you manage your LLC. An LLC could be managed by a manager or by a certain member. If all of this paperwork is confusing for you or you don’t want to deal with all the details, you can always hire professionals that can take care of this job for you. You can hire a lawyer or you could contact an online legal service that will do this job for you. An online service will cost you less than an attorney, so make sure you check your budget before asking for help.
Select an LLC operating agreement
Depending upon the state you reside in, you might have to file some extra paperwork when registering as an LLC. Certain states require business owners to create an operating agreement for their LLC. This takes the form of an official contract that will describe in detail the ownership of the business and all its management. This also includes additional details like what is the share of each member in the business, how are profits and losses going to be distributed between all the members, what are the voting rights of each member etc. It should also state the procedure that will be followed when someone leaves the business. Therefore, it is highly recommended to fill this document even when it is not compulsory because it can be used to clarify misunderstandings regarding any verbal agreements between business partners. Once again, you can hire a professional and let him fill in your required information.
Register with the IRS
Once you are done with setting up your LLC, it’s time for you to register it with the IRS. The first thing you need to apply for is an Employ Identification Number. This number is important as it will used for a variety of purposes. You will have to use your Employ Identification Number for acquiring business credit, filing taxes, opening business bank accounts and handling payroll. When it comes to filing your taxes, you can treat your LLC as a partnership or a corporation.
Update your bank and insurance information
With your shift to an LLC, you will also have to update your bank information. If you have any bank account that was used during your days as a sole proprietorship, it’s time to close it. Your next step will be opening a new business account that reflects your status as an LLC. This new bank account will use your new Employ Identification Number. This new account will now act as your business account and will be kept separate from your personal savings account. Also it might be a good idea to give your business insurance company a heads up regarding your structure change. Depending upon the insurance company, you may have to buy a new insurance policy.
Acquire business licenses and permits
Finally, it is important that you apply for any licenses and permits that are necessary for running your business. Of course, the most obvious one includes the business license. Other certifications could involve health department permits, reseller permits and any other licenses and permits that are required by your state. You may also have to gain a new business license after changing your structure.
So, there you go. By following these simple steps you can change your business structure form sole proprietor to a Limited Liability Company. The process will require some time to complete and as aforementioned, you can seek professional assistance if necessary.