Maybe, you’re tired that your personal liabilities and assets aren’t protected. Or perhaps you don’t want to keep paying steep personal taxes? Either way, you’ve made your decision, and want to make the jump from sole proprietor to single-member LLC owner. How do you do that? What steps do you need to take in order for the transition to go smoothly? Read on to find out! (Plus why you might reconsider that Kansas secretary of state business entity search.)
1. Do Your Research
Conduct a business name search on your state’s secretary of state website to see if your business name is available. Not doing so and filing under the name anyway may result in a cease and desist letter. Or, worse, cause greater legal ramifications, such as a lawsuit.
You’ll also want to see if you need an employment identification number (EIN) from the IRS. This will be the case if you never had one as a sole proprietor and you’re paying excise taxes and have employees. That or the EIN is under a different name, or you want to be taxed as a corporation instead of the standard partnership tax designation.
In addition to a business name search and EIN research, it’s important that you check with your state if you need to reapply for business licenses and permits. Some states do specify that, under a different business structure, this is necessary. (It’s best to speak with your accountant about seeing if you need to get a different EIN.)
The same goes for an operating agreement, where some states—such as New York and Missouri—require it, while states like Arkansas and New Mexico only require that the agreement be written if it’s created. Still, other states may see it as optional versus mandatory.
2. Talk with Your Accountant
Business structure transitions can be tricky, with sole proprietorship to LLC being no exception. We recommend that you meet with your accountant beforehand to discuss your assets and liabilities that would be transferred after the transition. Loans are another good topic to discuss, as some loans may not be transferable. (You can also contact your bank about that.)
3. Decide If You Need an Operating Agreement
An operating agreement is an official contract for LLC members. Your standard operating agreement outlines the amount of stock each member owns, voting rights, how profits and losses are distributed, and how the LLC will function after a member leaves—whether via quitting, death, or bankruptcy. Operating agreements, in general, are beneficial since it is a legally binding contract, and can prevent miscommunication and disagreements between members. It’s best to include one, even if your state doesn’t require it.
4. Choose a Registered Agent for the LLC
A registered agent is an individual (the individual can be a member of the LLC) or entity that is legally responsible for receiving paperwork designated to the LLC. (Remember, the LLC is a separate entity from the members that run it.)
We recommend that you go to your secretary of state page to see if you need to list an individual or entity as the LLC’s registered agent, as, depending on the state, you may be able to simply put the Secretary of State office.
5. File a Fictitious Business Name
Legally speaking, you are not required to file a fictitious business name or doing business as (DBA) if you plan on using the name recorded in the articles of organization. You do, however, need to file one if you intend to use another name. Normally, you file it with the county you do business in. Depending on the state you reside in, you may have to formally announce the DBA in the county newspaper to make your DBA official.
As stated in an Entrepreneur article, not filing a DBA means you won’t be able to open a bank account with that name. Also, you won’t be able to sue on behalf of that name should a time require it.
6. File the Articles of Organization with Your Secretary of State Office
The articles of organization is a mandatory set of documents you need to fill out when applying for an LLC. Depending on your state, it may be called articles of incorporation or it’s under a different name. Typically, articles of organization will include the name and address of the LLC, what the LLC’s goal is, the registered agent’s name and address, and whether the operation will be managed by members or managers. (Please know that you may need the managers’ and members’ signatures on the agreement.) Know that, along with the articles of operation, you’ll also need to supply a filing fee. Filling fees range from $50 in states—like Colorado, Arizona, and Hawaii to name a few— to $250 in Alaska.
How to Write the Articles of Operation
Just the name alone makes it sound like an operating agreement is extremely complicated, however most agreements only need the details listed above. Also, as this article states, know that some states already have pre-printed operating agreement for you to fill out. (You can look to your secretary of state page for more details.)
7. Get the Word Out About Your Transition
You want to contact anyone who does business with you about your transition from sole proprietor to LLC—this means clients, vendors, and employees. Do this especially if you’ve also changed the location of your business to ensure mail and prospective clients don’t end up in the wrong building, and that clients can make out the payment to the right business. You’ll also want to make changes to your business cards and invoices if you’ve registered a DBA.
8. Stop Using Anything Related to Your Past Business Entity
According to this article, your new bank account for the LLC will have the official “LLC” designation listed to the account, in addition to being on checks and the debit card. Continuing to use the account associated to your sole proprietorship will only bring confusion, much less potential consequences given that the sole proprietorship does not exist anymore.
(Know though that it is required to pay any outstanding expenses from the sole proprietor account. However, this should be done before you transition fully to an LLC.)
9. Remember the Differences
When you’ve made the transition from sole proprietor to LLC member, it’s important to remember that your personal and business assets stay separate. To show the IRS that this is true, you should open up a business bank account, and make sure that only business transactions go through that account to avoid any ramifications. Also, remember that even though your business is an LLC, you still have to make quarterly taxes to the IRS on April 15, June 15, September 15, and January 15.
Transitioning from sole proprietorship to limited liability company is a normal process (and a positive business move). Typically, entrepreneurs and business owners start as sole proprietors since they require the least amount of startup costs and generally don’t need any investors. The problem though is that when businesses do experience growth, staying as a sole proprietor can be expensive, as the personal tax rate generally is higher than the corporate tax rate. This is when sole proprietors jump ship and transition to an LLC, which provides a lower tax rate and limited liability benefits. Overall, make sure you do your research and speak with an experienced financial advisor and business lawyer to ensure that you’re checking all the right boxes.
Have any other advice about making a smooth transition from sole proprietor to LLC member? What obstacles did you run into and how did you get over them? Leave a comment in the comment section below!