A sole proprietorship is owned by one person while multiple people own an LLC. A sole proprietorship is a form of business organization where you operate under your name. You are responsible for paying taxes, keeping records, and filing reports. If you fail to do those things, it could mean fines, jail time, or both.
An LLC is a type of business organization that allows owners to limit liability. This means the owners aren’t personally liable for debts incurred by the company. Instead, the owners are held accountable for what happens within the company.
If you’re considering starting a business, consider whether operating as a sole proprietorship or forming an LLC makes sense.
Advantages of switching from sole proprietor to LLC
A sole proprietorship is taxed different than an LLC. Sole proprietorships are taxed based on net income while LLCs are taxed based on profits. If you operate a small business, it might make sense to form an LLC because it allows you to personally pass through tax savings to you.
Pass through taxes allow businesses to avoid double taxation. For example, let’s say you run a restaurant and earn $100,000 per year. You could file your personal federal 1040 Schedule C form and report your restaurant’s gross sales ($100,000). However, you would still owe self-employment taxes on those same earnings under current law. This is where a pass-through entity comes into play. By forming an LLC, you can set up a separate business account and use that money to pay yourself. When the IRS receives your annual return, they see that you earned $100,000 in profit, but you paid no self-employment taxes. Instead, you used the profits to pay yourself.
Ownership structure determines who will be liable for paying taxes. In some cases, sole proprietorship owners must file a corporate tax return even though they do not employ anyone. On the flip side, owners of an LLC can elect to be treated like a corporation and file a single tax return.
How to transition from sole proprietorship to LLC
A sole proprietorship is an organization owned and operated by one person. This includes businesses such as restaurants, retail stores, construction companies, real estate agents, doctors, dentists, lawyers, accountants, etc. Sole proprietorships are relatively simple to set up because there is no formal structure or organizational chart. However, it does come with certain drawbacks. One of those drawbacks is that you are personally liable for any debts incurred by the business. Another drawback is that profits earned by the business go directly into the owner’s pocket.
An LLC is a separate legal corporation that protects both the owner and the business. If the business fails, the owner isn’t responsible for the debt. Instead, the owner receives a distribution of the remaining value of the business. Profits remain within the LLC, allowing the owner to keep more money.
There are several steps involved in changing a sole proprietorship to an LLC. First, decide whether you want to convert to an LLC. Next, determine how much risk you’re willing to take. Finally, make sure you understand what happens to your current clients and employees.
1. Check your business name
Your business name must comply with local laws. In most states, you’ll need to register your business name with your county clerk. If you’re starting a business in California, check out our guide here.
If you plan to sell products online, make sure your domain name includes your brand name. For example, if you want to start selling shoes online, you might choose www.shoesbyjoe.com. You could also go with www.myshoesstore.com or www.mynewshoes.com.
Don’t infringe on trademarks
You can’t call yourself something that someone else owns the trademark for. So if you’re planning to open up a restaurant called “The Burger King,” you’d better find another name.
Be careful about what you include in your business name
Some businesses are allowed to use certain terms in their names, while others aren’t. For example, you can use the term “coffee shop” in your business name, but you cannot use the phrase “Coffee Shop Inc.” because that’s too similar to Starbucks’ trademarked slogan.
2. File articles of organization
To form an LLC, you must file Articles of Organization with your state’s filing officer. This document tells the public about your business structure and ownership. You’ll need it when you start doing business.
Most states require you to pay fees ranging from $100-$300 to do this. These fees are usually paid online or by mail. If you’re paying by mail, make sure you send your payment along with the forms. Some states won’t accept payments over the phone.
You can find out what state requires an LLC filing fee by searching “LLC Filing Fees.”
3. Write an LLC operating agreement
An Operating Agreement is required to form an LLC in most states. An Operating Agreement is a contract between the owners of the LLC, and it lays out the rules under which the LLC operates. In addition to defining the roles and responsibilities of each member of the LLC, an Operating Agreement typically includes provisions regarding:
1. Who owns what percentage of the LLC;
2. How decisions are made;
3. What happens if there is no owner of record; and
4. Other matters that affect the operation of the LLC.
The Operating Agreement must be signed by all members of the LLC. If you don’t know where to start writing one, here are some resources to help:
4. Announce your LLC
In Arizona, you must file a Certificate of Formation within thirty days of forming your LLC, unless it is a sole proprietorship. If you are filing under Chapter 4 of Title 10A, you must file an Application for Certificate of Formation within 30 calendar days of formation. You must provide proof of payment of fees and deposit of filing fee. A copy of the Articles of Organization must accompany the application. Failure to do so will cause the application to be rejected.
In California, you must pay a $25 annual renewal fee to maintain your registration. This fee is due no later than January 31st of each year. Filing fees are paid annually. Registration expires one year from the date of expiration.
Nevada requires a Statement of Organization or Amendment to be filed within ninety days of formation. There is a $10 filing fee. An original and three copies of the document must be submitted along with the filing fee.
If you want to start keeping track of your finances, it helps to separate your financial information into different accounts. This way, you won’t lose track of anything important.
You’ll need a checking account, savings account, credit card, debit card, retirement plan, investment account, and possibly even a small business account. You might already have some of those accounts, but if you don’t, here are five reasons why you should open up a new one.
1. Keep Your Money SafeSeparate accounts let you keep your money safe. If something happens to your main checking account, you could end up losing everything. But if you’re keeping your money in a separate account, you still have access to it. And if you do get robbed, there’s less of your money to steal.
2. Make Budgeting EasierKeeping all of your money in the same place makes budgeting easier. When you use multiple accounts, you can easily see where all of your money goes. Instead of having to dig through your bills and receipts, you just look at your monthly statement. Plus, you can make sure that you’re spending within your budget without having to go over every single transaction.
3. Track ExpensesEasily track expenses across all of your accounts. If you’re trying to figure out how much you spent on groceries this month, you can log into each of your accounts and pull up your receipt. Or, if you’re paying off student loans, you can check your balance in your loan account and see exactly how far along you are.
4. Save TimeReporting tax payments is easier if you keep all of the relevant documents in one spot. If you have to fill out 10 forms, it takes longer than if you had to fill out only one form. So, keep your tax paperwork together in one place. Then, you can file your return faster.
5. Get Started Right AwayOpening a new account doesn’t require a lot of work. Just head down to your local branch and set up an automatic payment. Once you’ve done that, you can focus on building your wealth.
6. Apply for an EIN
Apply for an Employer Identification Number (EIN) if your new LLC has three or more members. You will need an EIN if you are filing Form SS-4, Application for Employer Identification Number, or if you are applying for a Social Security number for your new LLC. If your new LLC has two or fewer members, you do not need an EIN.
Your new LLC must file a federal income tax return to avoid paying payroll taxes. This includes Form 941, Employer’s Quarterly Federal Tax Return; Form 940, Annual Federal Unemployment Tax Return; and Form 943, Withholding and Deposit Requirements.
An EIN is required to open a bank account. A bank cannot open an account without an EIN.
7. Obtain business permits and licenses
If you are starting a business in New Jersey, it’s important to understand how many licenses and permits you will need. You must obtain a variety of licenses and permits depending on the type of business you want to operate. For example, if you plan to sell products in retail stores, you will need to register with the Division of Consumer Affairs. If you plan to provide services such as accounting, legal advice, etc., you will need to register as a professional service provider with the Office of Attorney Ethics. And if you plan to offer goods or services online, you will need to comply with the rules set forth by the New Jersey Internet Sales Tax Act.
You can find out whether you need to file for any specific types of licenses and permits by checking with your local county clerk’s office. You can do this by contacting the County Clerk’s Office directly or by searching our Business Licenses Search Tool.
Frequently Asked Questions
Do I need a new EIN for my LLC?
If you already have an Employer Identification Number (EIN) for your Sole Proprtionership, you won’t be allowed to use it for your newly formed Limited Liability Company (LLC). This is because you are changing your legal status from sole proprietorship to limited liability company. To continue operating under the same name, you must obtain a new EIN.
The IRS requires businesses to file Form SS-4, Application for Employer Identification Number, within 30 days of opening a business. A separate form is required for each entity type. In addition, businesses with multiple entities must file an amended tax return annually.
Which is Better: LLC or Sole Proprietorship?
Whether you’re starting a business or already running one, there are pros and cons to both types of businesses. If you’re considering whether to incorporate or go solo, here are some things to consider.
An LLC offers limited liability protection for owners and investors, while a sole proprietorship provides no such legal protection. An LLC allows members to form sub-LLCs within the same state, whereas a sole proprietorship cannot do so. You’ll need to file articles of organization if you choose to set up an LLC.
Incorporation is required for most businesses operating out of states where doing so isn’t prohibited by law. In addition to filing paperwork, incorporation typically requires additional fees.
There are also tax benefits to incorporating. For example, corporations pay taxes on profits earned by their members, rather than having those earnings taxed twice—once when they’re paid to the member and again when distributed to shareholders. Corporations are also eligible for certain deductions and credits, including write offs for retirement contributions and depreciation.
As with everything else related to starting a business, it’s important to weigh the costs and benefits of each option carefully. Incorporating or setting up a sole proprietorship might make sense depending on your situation
James Rourke is a business and legal writer. He has written extensively on subjects such as contract law, company law, and intellectual property. His work has been featured in publications such as The Times, The Guardian, and Forbes. When he’s not writing, James enjoys spending time with his family and playing golf.
