Running a sole proprietorship is the simplest way to start a business.
But as your business grows, so do the risks.
Sole proprietorships don’t protect your personal assets, leaving everything from your house to your car vulnerable to business liabilities. If this makes you nervous, it’s time to consider transitioning to a limited liability company (LLC).
Forming an LLC gives you more than just a new name. It can also protect your personal property from business debts, provide you with tax options, and make it easier to hire employees.
Here’s a step-by-step guide on how to shift your business from a sole proprietorship to an LLC — and what to expect along the way.
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But first, you might be wondering …
Is an LLC right for my business?
It’s wise to consider the whole picture before choosing a new business entity. What’s right for one business owner might not be suitable for you.
Here are some things to consider when deciding whether an LLC is right for your business.
Liability protection
No doubt, one of the biggest perks of forming an LLC is personal liability protection.
As a sole proprietor, your business debts are your personal debts. An LLC usually protects assets (like your house, car, and savings) from business liabilities.
This means that if someone sues your business or it defaults on a loan, they can’t touch your assets.
Tax advantages
LLCs can offer tax flexibility, including the option to choose S-Corp taxation.
Why does this matter?
You could save on self-employment taxes with an LLC taxed as an S-Corp. Instead of paying taxes on all profits, you can designate part of your income as salary and the rest as distributions, which may incur taxes at a lower rate.
Hiring employees
If you’re considering hiring employees, transitioning to an LLC makes things easier.
People consider an LLC a separate entity from you, the owner. This makes payroll, employee benefits, and compliance with tax laws simpler.
State-specific restrictions
Depending on your profession, some states restrict certain licensed professionals (like attorneys and accountants) from forming an LLC.
Make sure to check your state’s rules before proceeding.
You might also want to meet with a registered agent specializing in LLC formation for more advice. More on this in a bit.
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Does transitioning to an LLC cost money?
Yes. Transitioning to an LLC also comes with costs you must budget for.
Here’s a breakdown of what to expect:
- Filing fees vary by state but typically range between $50 and $500. Some states also charge annual franchise taxes or LLC maintenance fees.
- Legal costs: Depending on the complexity of your business, hiring a lawyer to help draft your operating agreement, transfer assets, and ensure compliance can cost from a few hundred to a few thousand dollars.
- Tax consequences: If you transfer property or inventory, you may face tax consequences. Consult an accountant to understand potential capital gains taxes or sales tax implications.
6 steps to transition from a sole proprietorship to an LLC
If you’ve decided an LLC is the right move for you, here’s what you need to do to transition your business:
Step 1: Confirm your business name
The first step is to ensure that your business name is available. Check your state’s business name database to avoid any conflicts. You also want to ensure that no one else has trademarked your name.
A quick search on the US Patent and Trademark Office (USPTO) website can help you avoid legal issues.
If your preferred name isn’t available, consider choosing a unique variation. For example, try adding your location or a descriptive term to set your name apart.
Step 2: File articles of organization
Filing Articles of Organization forms your LLC.
This document includes key details about your LLC, like its name, address, and the designated registered agent (a person or company receiving legal documents on your LLC’s behalf).
Every state has its filing process, fees, and approval times, so check your state’s specific requirements.
The filing fee typically ranges from $50 to $500, depending on your state. Once filed, your LLC becomes an official legal entity.
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Step 3: Draft an LLC operating agreement
An LLC Operating Agreement outlines how you will run your business, how you will distribute profits, and each member’s role (if you have partners).
Even if you’re a single-member LLC, drafting this document is essential.
It can help prevent disputes, establish a clear profit-sharing structure, and show the IRS that you operate as a distinct business entity.
(While it’s possible to draft this yourself, consulting a lawyer to ensure the agreement covers all the necessary bases is wise.)
Step 4: Obtain a new EIN from the IRS
An Employer Identification Number (EIN) is like a Social Security number for your business. Even if you had one as a sole proprietor, you’d need a new EIN to form an LLC.
You can apply for one online through the IRS website at no cost. You’ll need it to file taxes, hire employees, and open a business bank account.
Step 5: Set up a new business bank account
Keep your personal and business finances separate to protect your limited liability status.
Open a new business bank account for your LLC and transfer all business-related funds. (This practice also simplifies accounting and makes it easier to track business expenses.)
Step 6: Apply for necessary licenses and permits
You might need new licenses or permits depending on your business type and location. Check with your local government to see if your current business license covers your new LLC or if you need to apply for a new one.
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Additional steps often overlooked during transition
Here are some more important steps to take when transitioning from a sole proprietorship to an LLC.
Transfer assets and liabilities
Once you form your LLC, you must transfer all business assets and liabilities from your sole proprietorship to the new LLC. This includes equipment, inventory, intellectual property, and contracts.
This is a “capital contribution,” meaning you invest these assets into your LLC.
You’ll also need to transfer other liabilities, such as loans and debts. Contact lenders to update your loan agreements so that the LLC is now responsible. Remember that some lenders might require personal guarantees, even with an LLC.
Update business contracts and agreements
Update every contract and agreement you had as a sole proprietor to reflect your new LLC status.
Review existing contracts with clients, suppliers, and vendors to determine whether you need to reassign them. Then, let all relevant parties know about the change.
(Be sure to also update your business cards, website, marketing channels, and online listings.)
Hiring professional guidance
Transitioning from a sole proprietorship to an LLC is a big step. Having professional help can save you time, money, and stress. Plus, you’ll breathe easier knowing you’ve set everything up correctly.
Consider the following support options:
- LLC formation services: These services can handle everything from filing your Articles of Organization to drafting your operating agreement.
- Make sure to choose a reputable service with experience in your state.
- Professional legal advice: A lawyer can help you draft contracts, transfer assets, and comply with state laws.
- Look for an attorney who specializes in small business law.
- Tax planning: An accountant can help you navigate tax implications, including the benefits of electing S-Corp status.
- Choose an accountant who specializes in working with LLCs.
Wrap up
Transitioning to an LLC may provide personal liability protection, tax flexibility, and a more structured business framework. However, it is important to weigh the costs and benefits before making the leap.
Following these steps and consulting with the right professionals can set your business up for success.
Legal Disclaimer:
Regardless of your chosen entity, a business lawsuit may still hold you personally liable. Even if you choose an LLC, consider consulting with a registered agent before choosing your business entity.
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