How to Transition From a Sole Proprietor to an LLC

by Deborah Sweeney

Is it ever too late to change the legal structure you initially incorporated as? Not at all. The entity formed for a business at its offset does not need to be its formation forever. Entrepreneurs have the option to change structures that best fit their needs, and many begin as sole proprietors. For those that are ready to make the leap from sole proprietorship to another entity type, like an LLC, here are a few tips to keep in mind.

1. Determine if you are truly ready to opt out of being a sole proprietor.

There are certain aspects of incorporating as a sole proprietorship that cannot be found in other legal structures. A couple perks include the ability to be the sole owner of the business and call the shots. This allows entrepreneurs to exercise complete control over their startup and truly act as the boss. A sole proprietorship is the easiest legal structure to form with a simplified tax process and affordable filing fees. It’s also a great entity if you run a business from home, like an Etsy shop or as an online consultant, where you don’t need a physical storefront.

However, the biggest drawback to remaining a sole proprietor is that there is no separation between personal and professional assets. The owner is liable for everything that happens within the business. This can include everything from losing valuable information to assuming the company’s debts and even being served with a lawsuit. Without liability assistance, it can be tough for an entrepreneur with a sole proprietorship to expand their business and protect their assets.

2. Decide whether an LLC or another entity formation is your best fit.

Before you can incorporate as a limited liability company (LLC), you’ll need to determine what each entity can bring to the table and your business.

As one of the most popular entities, an LLC allows entrepreneurs to keep their personal and professional assets separate. This is especially helpful in the event of an unforeseen circumstance and provides a growing startup with an extra cushion of liability protection. It also provides flexibility in being able to choose either an S Corporation or C Corporation as your tax entity. For those that qualify as an S Corporation, careful planning will allow you to avoid paying significant employment taxes. Keep in mind, however, that it’s not enough to incorporate as an LLC and be completely done with the process. You’ll also need to apply for permits (like a Sales and Tax permit, per obligations in your city, county, or state), business licenses and insurance, a DBA (Doing Business As name), and an EIN (Employer Identification Number).

For those with big expansion plans, a corporation offers the best of both worlds. You’ll receive liability protection for professional and personal assets within a formal business structure. This entity allows potential investors to invest capital into your business, provides the ability to issue shares, and makes it possible to take your business public. As far as taxes go, what you pay in taxes is based on what you choose to pay yourself from the corporation. You also have the option to elect an S Corporation status after incorporating to tax the shareholders, instead of the income of the corporation.

3. Look into a partnership.

Want a little extra support? A partnership is tailor-made for entrepreneurs that want to go into business with a partner, whether that’s a family member or friend. This structure allows entrepreneurs to share profits and losses with a partner and make decisions together.

Keep in mind that much like a sole proprietorship where you are liable for everything within the company, in a partnership you are liable for decisions made along with the actions of your business partner. Consider drafting a written partnership agreement together. This will allow you to establish partnership terms and outline capital contributions from each partner and their percentage of ownership in the company. You may also further detail the rules for admitting a new partner and outline procedures for the voluntary and involuntary withdrawal of the partner.

Once you have determined which entity formation you’d like to transition to, begin filing the proper paperwork with your local Secretary of State and pay the associated filing fee to make the changes.