For many sole proprietors who are seeing their micro-businesses grow and expand, there comes a point when the question of upgrading to an LLC becomes a major consideration. The possibility of converting to a corporation business structure also comes up on the radar screen.
Many entrepreneurs start off with a sole proprietorship because it’s cheaper and easier to get going than any other option. Plus, they may not yet be sure if their new startup is going to last or if business risks will be weighty enough to merit LLC or corporation status.
Then, as it becomes clear their business is surviving and thriving, they begin to wonder if it’s time to learn how to start an LLC.
How to Know It’s Time
Here are some of the best ways to know it’s time to make the switch to a limited liability business structure:
1. New Business Partners or Employees
If your business is now employing someone else besides just yourself on a permanent, full-time basis or if you want to team up with one or more other people in order to pool your talents and business assets, a new business setup may be required or at least highly advisable.
2. Expanding Customer Base
The more customers you have, the better. An expanded customer base also means greater possibility of liabilities if a product or service or negligence of some kind harms a third party (or even allegedly does so). Commercial general liability insurance is part of the answer, but further protections are added when you become an LLC.
3. More Assets, More Profits
It’s wonderful when your business’ assets and business profits mushroom, but the fact is, the IRS may think it’s wonderful as well and help themselves to increased tax rates. An LLC separates your business from personal income so that you can avoid paying self-employment tax on your salary. That, and other factors, can combine to lower your tax burden.
Things to Be Aware Of
Once you know it’s the right move, however, you might still want to wait till the end of the year (if it’s only a few months off) to change from sole proprietorship to LLC. The reason is that you may not want to have to file two sets of taxes for a single year for the same business, plus your personal tax return.
Also, you may need to get a new EIN when you upgrade to an LLC, although that can depend on the details. There are many exceptions and complexities, for example, whether you file taxes as an S corporation under your new LLC status can affect this.
Understand that an LLC protects your personal assets against lawsuits against the business, but that there is still the possibility of personal liability for negligence. And in some states, there are ways for business creditors collecting on loans to LLCs to force the issue and get reimbursed one way or another. In other words, LLCs offer significant added protection but shouldn’t be abused either.
Finally, you will also need to get a new business bank account, if you have one currently, when you upgrade since the new business name will differ at least in that it includes the ending “LLC.”
The paperwork involved in switching to an LLC is greater than anything required for a sole proprietorship. However, there are many legal services specializing in helping companies make this status transfer smoothly and successfully, and the advantages of upgrading far outweigh the cost and effort.
For many, the protections, tax savings, and flexibility of being a limited liability company make this the best option when a business is growing beyond the point where a sole proprietorship is adequate anymore.
