- When does it make sense to switch to an LLC?
- What is the legal process of switching from a sole proprietorship to an LLC?
- How can you make this switch as quick and easy as possible?
Q: How do I change from a sole proprietorship to LLC with IRS?
A: First, file your articles of organization with the IRS. Next, register your business as an LLC. The last stage is to reapply for any licenses you might need to operate legally in your state.
An increasing number of sole proprietors are registering their companies as LLCs in the United States.
From 2001 to 2008, the number of sole proprietorships registered as LLCs jumped from about 127,000 to almost 843,000.
While sole proprietorships are still the most common type of business in the United States, entrepreneurs across the nation are quickly realizing just how beneficial LLCs can be.
In fact, the Pew Research Center reports that about 30% of all jobs are held by self-employed individuals and their employees.
If you’re waking up to these advantages, you’re probably trying to figure out how to switch sole proprietorship to LLC.
The process is quite simple:
- Get help from professionals
- Research, choose and reserve a name for your LLC
- Designate a registered agent
- File your articles of organization
- Create an operating agreement
- Re-register your new LLC with the IRS
- Make sure you have the necessary licenses and permits
- Get insurance
- Create a business account for your LLC
If this seems a little complex, don’t worry. We’ll cover each of these steps in more depth.
Read More: Using a Virtual Address for LLC Registration
While transitioning to an LLC can seem like a daunting process at first, you’ll quickly learn that it’s much easier than it appears.
But why should you even choose an LLC in the first place? What are the advantages of this business type? And how can you make the switch as easy as possible?
Let’s find out…
- When should you switch from a sole proprietorship to an LLC?
- What do I need to do in order to switch from a sole proprietorship to an LLC?
- How can I make this process as easy as possible?
When should you switch from a sole proprietorship to an LLC?
So why should you even consider an LLC in the first place?
An LLC offers a number of advantages, including:
- Legal protection
- Tax benefits
- More flexibility
Legal Protection
Many entrepreneurs are primarily attracted to the legal protections offered by an LLC.
The truth is that even the most innocuous, innocent businesses can be sued. If you’re running a sole proprietorship, your personal assets are under threat whenever you face a lawsuit.
This means that if someone sues you for everything you’re worth, you could lose your house, your car, and even your prized collection of baseball cards.
And remember, you could be sued by your customers and your employees. Whether a customer slips and falls in your store or an employee files a sexual harassment claim against you, you could lose everything.
An LLC provides you with a layer of protection against these lawsuits, and it helps keep business and personal assets separate. This means that if your business is sued, plaintiffs can only take what belongs to the LLC – not what belongs to you personally.
As long as you keep your personal and business assets separate, you can enjoy these reliable legal protections.
Tax Benefits
In many ways, a single-member LLC is virtually identical to a sole proprietorship in the eyes of the IRS. When you switch sole proprietorship to LLC, IRS officials don’t really care because unless you select certain tax statuses, nothing has changed from their perspective.
In fact, the IRS classifies single-member LLCs as “non-existent entities.”
This is because profits from normal LLCs are passed through to you as personal income, and normal LLC owners simply pay taxes on this income through their personal tax returns.
This is advantageous because you avoid the “double-taxation” issue that is often seen with other corporation types.
It’s also worth mentioning that an LLC can experience “flat taxes” that do not change based on normal income brackets. With an LLC, you can avoid being taxed at a higher rate simply because you earned more money in the previous year.
For example, states like California have a flat tax of about 8.8% for many eligible LLCs.
More Flexibility
An LLC can be taxed in many different ways, providing a considerable degree of flexibility.
While you can choose the normal taxation method for LLCs and experience “pass-through” taxes, you can also choose to be taxed as an “S-Corp” or a “C-Corp.”
An “S-Corp” is technically a tax status rather than a type of business. This option allows you to pay yourself a “reasonable salary,” which results in tax-exempt dividends and a reduction of self-employment taxes.
A C-Corp helps you keep funds inside the business while paying yourself dividends. You can invest money that is kept within the business, growing your funds without paying as much personal income tax. While C-Corps are subject to double-taxation, they can be highly advantageous with the right strategy.
The point is simple:
An LLC gives you almost unparalleled flexibility, allowing you to choose exactly how you want your business to be taxed.
It might be worth speaking to a financial adviser or accountant to determine whether an LLC, S-Corp, or C-Corp is most advantageous based on your unique needs and priorities.
Downsides to an LLC
Of course, LLCs come with their fair share of disadvantages, and some might prefer to stick with sole proprietorships for several reasons, including:
- You have virtually zero chance of being sued
- You do not plan to have employees or expand
- You like keeping things small-scale and simple
- You don’t like paperwork
- You don’t have any extra money for the cost of starting an LLC
- No unemployment tax
What do I need to do in order to switch from a sole proprietorship to an LLC?
Let’s go through the steps you’ll need to take to switch from a sole proprietorship to LLC.
1. Get help from professionals
If starting an LLC seems like a daunting process, you can make it easier on yourself by working with qualified professionals.
Lawyers, financial advisors, and accountants can all lend a helping hand. If you’re seriously busy with your business and you have no time to go through the following steps, you can pay a professional to take care of this for you.
This is something to consider, as the opportunity cost is real. Just because you can fill out the various paperwork necessary for your new LLC, this doesn’t mean you should.
Your skills as an entrepreneur are capable of generating considerable profits if you focus on your business – paying for the cost of professional help many times over.
That being said, some people simply enjoy being independent and doing things themselves, and forming an LLC on your own will help you understand the “inner workings” of this business.
2. Research, choose, and reserve a name for your LLC
Even if you already have a name for your sole proprietorship, you’ll need to officially select a new name for your LLC. The name selection process is surprisingly important, as this name will form the basis of a new legal entity.
For example, if you’re running a lawn mowing company called “Green Grass Lawn Care,” you can simply choose to register your LLC as “Green Grass Lawn Care, LLC.”
However, choosing a name isn’t always that easy since you cannot select names that have already been taken or trademarked.
Often, your local state government will allow you to pick three potential names for registration. If your first choice is not available, then your second pick is used. If your second choice is taken, your third pick is used.
It makes sense to research potential name choices before attempting to reserve them. For example, you might discover that “Green Grass Lawn Care” is already taken by another lawn care company in your state.
As a result, you might change the name slightly to something like “Greener Lawns, LLC.” If this name is available, you’re good to go.
The last thing you need to consider is trademarks and copyrights. For example, you might choose to name your new tech company after your favorite superhero.
Unfortunately, many names are considered “intellectual property,” and you could run into legal issues if you name your business after certain concepts in the public domain.
The good news is that most states today offer free searchable databases to help you research your new name. In addition, you can search for copyrighted words and phrases on a global scale with free online websites.
Once you have your name, simply add “LLC” or “Limited Liability Company” to your business’ official title, and you’re good to go.
3. Designate a registered agent
A registered agent is your business’ official point of contact. This is the individual who will be contacted by the IRS, state authorities, and various other governmental organizations.
If you’re running a single-member LLC, you can simply designate yourself as the registered agent.
While there’s nothing wrong with designating yourself as a registered agent, your attorney can also fill this role. This saves you from being contacted by the IRS directly, and it helps your attorney handle issues directly and efficiently.
Of course, many small businesses cannot afford to work with an attorney. Because of this, it is very common to designate yourself as the registered agent.
4. Choose Your State
One of the most important steps you’ll need to take if you want to switch sole proprietorship to LLC is to choose your state.
But hold on a second… Shouldn’t you simply pick your home state? After all, what other choice is there?
With modern technology and innovative companies like Alliance Virtual Offices, you can choose any state you want when registering your new LLC.
You can do this by taking advantage of something called a “virtual address.” This strategy is completely legal, and it allows you to establish your LLC in the most advantageous location.
For example, some states may have much more attractive tax rates than others. By registering your LLC within one of these states, you can save considerable sums each year.
You might also want to choose a certain state because of the inherent reputation associated with it. For example, a tech company registered in Silicon Valley seems much more innovative than a tech company registered in Kansas.
The same goes for a financial company registered in New York – even if the LLC owner is physically based in Hawaii.
A virtual address also provides additional benefits, such as:
- Increased privacy
- Mail forwarding
- Keep your business and personal life separate
- Less mail sent to your home
If you’d like to explore the possibilities of a virtual address further, reach out to Alliance Virtual Offices.
5. File your articles of organization
Next, you’ll need to file your articles of organization.
This document contains important information about your new LLC, including:
- Your business name
- Your business address
- The registered agent
- The names of the members
- How the LLC will be managed
- The purpose of the LLC
- The LLC’s duration
- How you wish to be taxed
The articles of organization are sometimes referred to as “articles of incorporation.” Remember, each state has its own process involving the articles of incorporation.
You’ll need to research the relevant requirements for your specific state before you file your articles.
6. Create an operating agreement
The operating agreement is only required by certain states.
If your state requires you to create an operating agreement, the process is quite simple. An operating agreement contains information about the management and ownership of the LLC, including share distribution, voting rights, and how profits are distributed.
Samples of operating agreements are easy to find on the web.
7. Re-register your new LLC with the IRS
Once you’ve carried out these steps, it’s time to register with the IRS once again. If you already have an EIN that you were using with your sole proprietorship, you’ll need to apply for a new one.
If not, you’ll need to apply for an EIN for the first time. You’ll need your EIN to open business accounts, file taxes, and a range of other tasks.
8. Make sure you have the necessary licenses and permits
You may also need to re-apply for various licenses and permits within your state. This is because you are now operating as a separate legal entity, and your new LLC does not have the necessary permits – even if your sole proprietorship did.
Keep in mind that certain professionals are not allowed to form LLCs. In addition, non-US residents cannot form LLCs.
9. Get insurance
After you’ve carried out these steps, it’s time to make sure you are properly insured. Again, this is necessary because you have formed a new legal business entity.
Once you switch sole proprietorship to LLC, you will no longer be covered under your previous insurance held by your sole proprietorship.
10. Create a business account for your LLC
Once you’ve obtained your EIN and your new LLC is approved, you can create a new business account under this separate legal entity.
Remember to keep personal funds and assets out of your LLC account and avoid your business account for personal needs.
How can I make this process as easy as possible?
There are many ways you can make this process as easy as possible, including:
- Establish your business credit as soon as possible: As soon as you have established your LLC, you need to start building credit with your business. Since your LLC is an entirely new business entity, you’re essentially starting from scratch – even if you have great credit yourself.
- Get professional help: As mentioned previously, professional help can go a long way as you enter the world of LLCs. It may be well worth the money, and you can also use online services.
- Apply for grants and loans: As you switch sole proprietorship to LLC, you might want to take the opportunity to learn about new loans and grants. This source of funding can help you pay for the costs associated with forming an LLC.
- Choose the right tax status from the beginning: It’s best to think long and hard before you choose your tax status. Consider getting advice from a legal or financial professional. Making the right decision from the very beginning saves you from having to fix things later – whether you choose a normal LLC, an S-Corp, or a C-Corp.
- Consider a virtual address: This is also a great time to consider a virtual address. A few minutes or hours of research could save you huge amounts of money in the long run. Nothing is stopping you from registering your business in a state with zero corporate tax.
Moving forward with your new LLC
While sticking with a sole proprietorship certainly has its benefits, no one ever won any medals by playing it safe.
Entrepreneurship is all about being bold and adventurous, and the decision to switch sole proprietorship to LLC can be highly profitable.
There’s very little risk involved with establishing an LLC aside from the minimal fees and a few hours of annoying paperwork.
Indeed, not forming an LLC could be the riskiest move of all. Remember, your sole proprietorship makes you incredibly vulnerable to lawsuits. The sooner you protect your personal assets with an LLC, the better.
With inflation on the rise, exploring advantageous tax strategies is a must.
At the end of the day, switching from sole proprietorship to LLC isn’t that difficult.
And with service providers like Alliance Virtual Offices, it’s never been easier to experience considerable tax benefits, increase your reputation, and boost your business to the next level of success.
Check out Alliance Virtual Offices today for more information on virtual addresses, live receptionists, and much more.
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