June 1, 2021
Moving from a Sole Proprietorship to an LLC
You started a business and, as it grows, you want to make sure you are optimizing tax benefits, protecting yourself from liabilities, and establishing legitimacy for potential funding. So, what do you do? Your first step is to take your sole proprietorship and form a Limited Liability Company (LLC).
As a sole proprietor, you are your business, and your business is you. This means that anything you own, your business owns, and any legal issues the business may have, such as a lawsuit, are your legal issues. One of the greatest advantages of forming an LLC is that it provides limited liability for you as the business owner. The LLC is its own legal entity, separate from the individual owner. With an LLC, the owner can keep their personal assets, debt, and legal issues separate from the business’ assets, debts, and legal issues.
Another advantage of forming an LLC is that you’re one step closer to tax savings, which you can learn more about in this blog post about the S-Corp structure.
Forming an LLC requires several steps. First, you must know the rules and regulations in the state where you operate, since every state is a bit different. Generally, you will file documents with the Secretary of State and receive a Certificate of Formation. Check the state and local business licensing requirements. It is a good idea to check for any special licensing requirements based on your industry, profession, or occupation.
Next, you need to obtain an Employer Identification Number (EIN) from the IRS as a sole proprietor if you have employees or file pension or excise tax returns. However, obtaining an EIN for your LLC is another way to separate the individual owner from the business and protect your personal identification. Without an EIN you would use your personal social security number (SSN) as the tax ID for the business. You can provide your customers and clients a Form W-9, Request for Taxpayer Identification Number and Certification, using the business name and EIN. They can use this information to issue a 1099-MISC or 1099-NEC to the business to report payments.
With your LLC formed you can tailor advertising for your company. You can update, or create, a company website, and design a logo and business cards. Creating custom invoices through your bookkeeping software and adding your logo is another way to promote your business. Opening a separate business bank account in the company’s name is another good step.
Single-member LLCs that maintain taxation status as a sole proprietor, may take a distribution, or draw, from the company. You will still need to pay self-employment and federal taxes on 100% of the profits, regardless of whether you take the distribution or leave the profits in the company to cover future costs. This is why many self-employed professionals migrate to an S-Corp, which can save thousands in self-employment tax.
As an LLC you need to stay in compliance to operate in the State where you formed. Most states require both domestic and foreign LLCs to submit an annual report. This document ensures that the company information on record is accurate and current. Generally, this filing requires payment of a minimal fee. Renewal of business licenses may need to occur on an annual basis. And, each state will have different taxation filing requirements, depending on whether they impose a state income tax, a sales and use tax, or a business tax that you will file and pay.
While the LLC is definitely the first step for a business owner, it's still one step away from tax savings. That’s why many take the last step and transition their LLC to an S-Corp, opening an entirely new world of opportunities, including significant tax savings, retirement saving options, and other benefits. To learn more about the different business structures available, read our blog: LLC Vs C-Corp Vs S-Corp
The professional consultants at Formations are available to look at your current situation and assist you in making the transition to an LLC when the time is right. We are here to help!