How to Change From Sole Proprietor to LLC in 5 Steps

Are you thinking about transitioning from a sole proprietorship to an LLC? It doesn’t have to be complicated. Shifting your small business to an LLC structure protects your personal assets and enhances the credibility of your business. 

If you’re wondering how to convert your sole proprietorship to an LLC, we’re here to help you with an informative and easy-to-understand guide that explains the entire process step by step. 

Key Takeaways

• A limited liability company (LLC) is a hybrid business structure that combines the personal liability protections of a corporation with the flexibility of a sole proprietorship.

• Many entrepreneurs and small businesses start as sole proprietors and convert to LLCs later down the line. 

• To form an LLC, you must file Articles of Organization, appoint a registered agent, and obtain an EIN. 

What Is an LLC?

An LLC is a legal business structure combining benefits of a corporation and a sole proprietorship or partnership.

Limited liability companies provide personal liability protection to LLC owners, known as members, shielding their personal assets from business debts and legal liabilities.[1] If the LLC faces financial challenges or legal issues, the members' personal assets are generally protected.

Key benefits of an LLC include:

• Limited Liability: An LLC is a separate legal entity, and the members' personal assets are protected from business debts and liabilities.

• Pass-Through Taxation: Profits and losses "pass-through" to the members' individual tax returns, avoiding double taxation at the entity level.

• Flexible Management: Members can manage the LLC themselves or designate a manager.

• Ease of Formation: Forming an LLC is generally simpler than a corporation, with fewer formalities and paperwork.

• Perpetual Existence: An LLC can have a perpetual existence independent of changes in ownership.

LLCs are popular for small business owners due to their flexibility, liability protection, and favorable tax treatment. 

Sole Proprietorship vs. LLC

When deciding whether to transition from a sole proprietorship to an LLC, it’s essential to consider various factors to make up your mind. 

Personal Liability Protection

A sole proprietorship is a business structure where the sole owner is personally responsible for all aspects, including the business's debts and legal liabilities. There is no legal distinction between the owner and the business. As a sole proprietor, you virtually are your business.[2]

Many business owners form an LLC because it protects their personal assets. Forming an LLC legally separates you from your new business and shields your personal assets, such as your car or personal finances, from debts and legal liabilities of your business. Only your business assets are at risk if your LLC faces debts or legal actions. 

Opening a Business Bank Account

Having a separate bank account for your business activities is essential to make it easier to streamline your accounting and pay taxes. 

You may find it difficult to open a dedicated business bank account as a sole proprietor. To become eligible with most banks, you typically must file for a DBA (doing business as), which involves additional filing fees and legal documents. 

In contrast, opening an LLC bank account is relatively straightforward. LLC owners may need to provide a few documents to verify their business status, such as an EIN or an operating agreement. Still, it’s typically quite easy to open a new bank account for your business. 

Credibility

Many entrepreneurs and small businesses start as a sole proprietorship because it requires minimal paperwork. However, as your business grows, you may consider switching from a sole proprietorship to an LLC to enhance your credibility. An LLC is a more formal and established structure that helps your customers and partners take your business more seriously. 

How to Change From Sole Proprietor to LLC

Are you considering changing from a sole proprietorship to an LLC? The transition doesn’t have to be complicated. Here are the five steps to successfully form a new limited liability company. 

1. Choose a Business Name

The first step you need to take to change from sole proprietorship to LLC is to choose your LLC’s name. Deciding on your business name is an important step in establishing your brand identity. 

Here are some rules and considerations to help you choose a business name for your LLC:

• Availability: Ensure that the name you want is available and not already in use by another business in your state with a business name search.

• Trademarks: Check that your name doesn't infringe on existing trademarks. You can check the U.S. Patent and Trademark Office (USPTO) database or consult a trademark attorney for more comprehensive research.

• Domain Availability: Consider securing a domain name that matches or closely aligns with your business name. This can help with online visibility and branding.

• Restricted Terms: Under state law, certain restricted terms may require additional approvals. For example, finance, law, or healthcare terms may have specific regulations.

• Social Media Handles: Ensure your name is available on major social media platforms. Consistency across online platforms is vital for brand recognition.

If you have an existing DBA as a sole proprietor, you must cancel it or create a new one before forming an LLC. 

2. File Articles of Organization

The Articles of Organization, also known as a Certificate of Organization or a Certificate of Formation in some states, is a legal document you file with the state to officially create a limited liability company. 

The specific requirements for the information you need to provide in your Articles of Organization vary by state, but the typical components include: 

• Name of the LLC

• Principal place of business

• Whether it’s a single-member LLC or a multi-member LLC 

• Registered agent 

• Duration of the LLC 

• Purpose of the LLC 

• Management structure (member-managed or manager-managed) 

• Names and addresses of members and managers

• Effective date

• Signature(s)

Once you verify that all of the information you’re providing is correct, submit your Articles of Organization to the Secretary of State with your filing fee. 

3. Hire a Registered Agent

A registered agent is an individual or entity that receives legal documents, official correspondences, and service of process on behalf of your LLC. In most states, all limited liability companies are required to have registered agents. 

As an LLC owner, you can appoint yourself as your registered agent or hire a registered agent service. While serving as your registered agent may sound simple, there are a few important things to consider before deciding. 

Legal Requirements

Your registered agent is required to have a physical address within the state where your business is registered. They also must be present at that physical address during  business hours to receive legal documents. As an entrepreneur, you may find it difficult to be tied to one location Monday through Friday during regular business hours.

Privacy Considerations

Your registered agent’s physical address becomes a public record. If you are running your business from home or using your home address for your registered agent duties, your privacy will be compromised. 

4. Create an LLC Operating Agreement

An LLC operating agreement outlines your limited liability company's internal structure, management, and operating procedures. Even though not all states require business owners to draft an operating agreement, creating one is highly recommended during the incorporation process. 

The specific details of your LLC operating agreement can vary based on the nature of your LLC. Most operating agreements include the following information: 

• Business name and formation

• Purpose of the LLC

• Members’ contributions 

• Ownership interests 

• Profit and loss allocations 

• Management structure

• Voting rights

• Meetings and decision-making

• Dissolution

• Dispute resolution

• Governing law

You can tailor your LLC operating agreement to your business's specific needs and goals. 

5. Obtain an Employer Identification Number

An employer identification number (EIN) is a unique number the IRS uses to identify your business for tax purposes. Also known as the Federal Employer Identification Number (FEIN), it’s virtually a social security number for your business.[3] 

You typically need an EIN to open a business bank account and pay taxes, including income tax. You can apply for a new EIN on the IRS’s website, or we can obtain one for you.

Maintain Your New LLC

Once you have successfully formed your LLC, you need to take several steps to set up your business effectively. 

Open a Business Bank Account

Choose a suitable bank and open a business bank account using your EIN. This helps maintain a clear separation between personal and business finances. It also makes tax filing with the IRS significantly easier. 

Register with State Agencies

Check state-specific requirements and register your LLC with the appropriate state agencies. This may involve filing annual reports, updating business information, and staying compliant with state regulations.

Apply for Business Licenses and Permits

Identify and apply for any required local, state, and federal business licenses and permits. Most small businesses require some kind of business license or a permit to operate. 

Comply with Tax Obligations

Stay informed about your tax obligations. File taxes accurately and on time, and be aware of state and local tax requirements that may apply to your business.

FAQs

Is it easy to convert a sole proprietorship to an LLC?

Converting a sole proprietorship to a limited liability company (LLC) is generally straightforward. It involves choosing an available business name, submitting an Articles of Organization, and appointing a registered agent. 

Can I change my EIN for sole proprietor to an LLC?

No, you can’t change your existing Employer Identification Number (EIN) from a sole proprietorship to an LLC. You create a new legal entity when you transition from a sole proprietorship to an LLC. As a result, you will need to obtain a new EIN for the LLC.

What are the disadvantages of changing from a sole proprietorship to an LLC?

An LLC protects your personal assets and enhances your business credibility. However, managing an LLC involves additional administrative tasks and fees compared to a sole proprietorship. 

Is it better to start as a sole proprietor or LLC?

The decision to start as a sole proprietor or form a limited liability company (LLC) depends on various factors, including your business goals and personal preferences. That said, starting an LLC protects your personal assets from the very beginning of your entrepreneurial journey. 

How much does it cost to convert from a sole proprietor to an LLC?

The cost to convert from a sole proprietorship to a Limited Liability Company (LLC) can vary based on several factors, such as your state. At the very least, you can expect to cover LLC formation fees. 

Why would I want to change from a sole proprietorship to an LLC?

An LLC offers several advantages, such as personal liability protection, improved professional image and credibility, and a more scalable business structure. 

Bibliography

1. U.S. Small Business Administration. “Choosing the Right Business Structure: Three Factors to Consider.” Accessed December 11, 2023. 

2. U.S. Small Business Administration. “Choose a business structure.” Accessed December 11, 2023. 

3. Internal Revenue Service. “Employer ID Numbers.” Accessed December 11, 2023.