It’s the dream goal of any passionate entrepreneur: Business is booming and you’re finally ready to convert your business structure from sole proprietorship to LLC.
LLC owners enjoy multiple legal and tax benefits, and many business owners agree it’s worth making the change.
But before you make that leap, you need to decide whether a sole proprietorship or LLC is the best structure for your business, as well as learning the steps to switching from a sole proprietorship to a limited liability company (LLC).
What Is a Sole Proprietorship?
A sole proprietorship is an unincorporated business (not a corporation). It has only one owner, and the owner will pay taxes on the business on their personal tax return. Often, sole proprietors don’t fuss with registering business or trade names and instead conduct business under their own name.
Sole proprietorships are also called sole traders or proprietors. It’s the easiest business structure to get off the ground in most cases, and it’s the easiest to dismantle or dissolve.
Because of this, sole proprietorships are popular with individual contractors, consultants, and freelancers. Many businesses begin their lives as sole proprietorships before transitioning into corporations or limited liability companies at some point.
What Is a Limited Liability Company?
A limited liability company, or LLC, is a business structure exclusive to the US. LLC owners enjoy limited liability and personal liability or asset protection. The assets and liabilities of the business are automatically separated from the assets and personal property of the business owner.
LLCs provide pass-through taxation and limited liability, and, as such, they’re taxed differently than corporations. Owners of LLCs are only required to pay taxes on their share of the LLC’s profits on their personal income tax filings. Most business owners are drawn to LLCs because of personal asset protection and the tax benefits they provide.
How to Change From a Sole Proprietorship to an LLC
Making the switch from sole proprietorship to LLC may seem like a daunting task, but once you understand the process it’s actually quite easy. Here are the steps you need to take to convert your sole proprietorship to an LLC.
1. Obtain Articles of Organization, Certificate of Formation, or Certificate of Organization form
Although it’s called different names in different states, every state has a specified form for LLC formation. The first step to changing your sole proprietorship to an LLC is to get this form. It does three important things at once: declares the formation of your new LLC, legally establishes your LLC in your state, and names your LLC members.
In most cases, the articles of organization include basic information about your business, such as its name and address, registered agent, and information about your LLC members. Some states also require you to make a Statement of Business Purpose, as well.
Now is the time to choose whether your LLC will be member-managed or manager-managed. A member-managed LLC is run by LLC members who vote on the company’s high-level decisions. A manager-managed LLC is one in which one person is in charge of making important decisions.
2. Confirm Business Name Availability
Next on your journey from sole proprietorship to LLC is to choose a business name, make sure it’s available, and reserve it. To ensure that your business name isn’t already in use by another company, you need to run a business name search. You can typically search your state’s business name database for free on the Secretary of State’s website.
After you’ve confirmed the business name isn’t already in use, it’s a good idea to also run a search on the United States Patent and Trademark Office (USPTO) database. This will tell you whether your business name has already been trademarked and help you avoid any trademark and legal issues.
If there are no issues with your business name, look up your state’s laws about business name designations. Some states require LLCs to use some variation of “Limited Liability Company” or “LLC” in their business names.
You’ll then need to file a business name reservation form, typically called something like a “Reservation of Name” form. This form will secure your business name for a specified number of days (usually 120 days). You’ll likely be required to pay a filing fee to submit this form.
3. Choose a Registered Agent or Statutory Agent
A registered agent works as a sort of intermediary between your company, government agencies, and law firms. Some states refer to a registered agent as a “resident agent” or “statutory agent.” Most states require LLCs to maintain a registered agent, so this is the third step you’ll need to complete.
Registered agents must be available at your registered agent address during normal business hours to accept service of process and official mail on behalf of your business. You’re allowed to be your own registered agent, designate someone close to you that you trust, designate a business, or hire a professional registered agent service.
I reviewed, compared, and rated the 12 best United States registered agent services. You can read the full guide here: Best Registered Agent Services.
4. Choose Your LLC Address
Naming your LLC isn’t the only important consideration when filling out your formation documents. You’re typically required to list a business address for your new LLC as well. The address you choose to specify on your formation documents will be where your business’s mail and legal documents will be sent, which means it’s important.
If you’ve chosen to be your own registered agent, you’ll need to list your business’s physical street address. If it doesn’t have a physical street address, you’ve got no choice but to list your home address or home office address. It’ll go on the public record, so listing your home address puts you at risk for identity theft and other cybercrimes.
If you choose to hire a registered agent service, the company will list its registered agent address on the form. This address isn’t linked to you or your home, which protects your information.
5. File Your Formation Documents
After filling in the necessary information and double-checking it for accuracy, it’s time to file your formation documents. You’ll need to decide whether you’ll be signing the documents yourself or use an LLC organizer to sign the documents.
Of course, signing it yourself puts your information on public record. If you use an LLC formation service, then its information will be listed on public record, rather than your own.
Your state may also have a publication requirement. Some states require new LLCs to publish a notice of formation in newspapers for a certain number of days or weeks. Once this is done, you’ll get a certificate for meeting the publishing requirement, which you can present to your state government when you file your articles of organization.
Your state will likely provide you with filing options, online or in person. Whichever option you choose, there will likely be a filing fee to submit your formation paperwork.
After all of your required documents have been submitted, they will reach out to you (usually either through email or mail) after they’ve processed your payment and paperwork. The processing time varies by state, but you can estimate that it will take two to three weeks, less if you file online.
Some states offer expedited processing, which cuts the time down from weeks to a matter of days, directly from the Secretary of State, while others don’t offer it at all. In states without expedited processing, you can usually still find a business formation service with expedited processing services, for a fee, of course.
Advantages and Disadvantages of Sole Proprietorship
Some of the key benefits of a sole proprietorship include how cheap it is to form one, inexpensive maintenance, and pass-through tax benefits. Here are some of the benefits and drawbacks of sole proprietorships.
Advantages
Tax Benefits
As a pass-through business entity, your business is only taxed once as opposed to multiple times, like a corporation. Many sole proprietorships qualify for a 20% tax break due to the 2017 Tax Cuts and Jobs Act (TCJA), which established tax breaks for different pass-through entities, and up to a 20% tax deduction on qualified income.
This benefit is in effect until January 1, 2026 unless Congress extends or shortens it.
Easy Formation
You aren’t required to fill out loads of paperwork to form a sole proprietorship. You often aren’t required to obtain business licenses or register your business with the state. This means you can start your business in a snap.
Easier Taxes
Because of the “sole” in a sole proprietorship, you typically don’t have to deal with the same tax headaches that other business entities do, like hiring employees and obtaining an employer identification number (EIN) from the US Internal Revenue Service (IRS).
Of course, you can apply for an EIN if you want — they’re useful for tax purposes and such — but as a sole proprietor you’re allowed to use your social security number in place of an EIN or other tax identification numbers.
No Business Bank Account Required
Many business structures are required to open business bank accounts, but sole proprietorships are the exception to that rule. You’re allowed to run your business transactions through your own personal bank account.
Disadvantages
Here are some of the disadvantages of choosing a sole proprietorship.
No Legal Protection
Sole proprietorships don’t benefit from limited liability protection, as LLCs do. This means that if the business is sued, the business owner’s personal assets and finances are vulnerable.
Difficulty Raising Capital
You may find it hard to get funding or equity from financial institutions or investors. Because you’re liable as the owner, it’s difficult to obtain financial assistance. Financial institutions are more likely to work with businesses that have been around for a long time. Your new business and limited funds makes you a high-risk borrower.
Differences Between Sole Proprietorships and LLCs
There are a number of differences between the two business entities, so it’s good to know how they differ before switching from a sole proprietorship to LLC.
| Sole proprietorship | LLC | |
| Members | One member or owner | Can be one member or owner, or multiple organizations or members (such as a multi-member LLC) |
| Taxation | All sales and revenue are reported on personal tax returns | Company’s taxes are filed on the personal taxes of one of the owners. If there are two or more owners, then the company is treated as a partnership |
| Legal entity status | The business and the owner are considered the same entity | The company is a separate entity from the business owner or owners |
| Formation | The business is automatically formed when you start conducting business | The company is formed when you file articles of organization with your state government |
| Business name | You can operate under either a fictitious name or the business owner’s name. You’re also allowed to register a DBA or “Doing Business As” name. | The business name is formally registered and established with the state government. |
Reasons to Change From a Sole Proprietorship to an LLC
It’s easier and cheaper to form a sole proprietorship, but easy and cheap aren’t the only benefits to consider. Here are some reasons a business owner may switch from sole proprietor to LLC.
You Want Personal Asset Protection
As a sole proprietor, your personal assets are vulnerable if your business is ever sued. But thanks to limited liability protection, if you convert to an LLC, your finances and personal assets are considered separate from those of the business.
You Plan to Add a Business Partner
If you add a business co-owner as a sole proprietor, then your business automatically becomes a general partnership. One of the biggest disadvantages of a general partnership is that your liability exposure doubles.
This is because not only are you liable for everything your business does, you’re also liable for everything your partner does as the co-owner of your business. Yes, even if you didn’t know about the action or sign off on it.
But if you form an LLC, your personal assets and finances are secured no matter what your partner does.
You Want Tax Breaks
As a sole proprietor, you’re technically self-employed, which means you have to pay self-employment taxes. To get around that, many business owners opt to form an LLC and file taxes as an S corporation. Doing so classifies you as an LLC employee, and you’ll then pay payroll taxes on your salary, as opposed to the entirety of the company’s profits.
You Plan to Hire Employees
Contrary to what its name suggests, you can actually hire employees as a sole proprietor as long as you follow the appropriate tax and employment laws. But it may be easier for you to form an LLC in terms of both taxation and employee compensation. Plus, you get personal asset protection in the event that your employee ever has a legal dispute with your company.
Who Can’t Form an LLC?
Sure, LLCs sound great. But before you go rushing off to file your paperwork, you should know that not everyone is allowed to form one.
Some state governments restrict certain industries from forming LLCs, including banks, trusts, and insurance companies. Certain licensed professionals are also not allowed to form an LLC, such as accountants, doctors, architects, and attorneys.
Other LLC Activities
After you’ve formed your LLC and legally established it in your state, it’s likely that you’ll be required to take part in other business activities that fall outside of LLC formation, like drafting an LLC operating agreement.
Don’t be fooled into thinking these activities are less important than the LLC formation process — without them you could lose your company’s good standing. Here’s a look at some of the activities you may have to complete:
- Register with your state’s taxation department
- Submit an annual report
- Pay taxes and filing fees
- Apply for business licenses where applicable
- Draft an operating agreement
- Open a business bank account
Conclusion
There are a number of reasons business owners make the switch from sole proprietor to LLC, including personal liability protection and tax advantages. Once you’ve made the decision to change your structure to an LLC, the process isn’t difficult.
If you’d like to learn more about LLC formation, read How to Start an LLC. If you want additional support and assistance throughout the wild and confusing formation process, read the Best LLC Formation Services.
