Can You Change a Sole Proprietorship to an LLC?

AdobeStock_193656039-300x200Many Californians start their own business without creating a separate legal entity. An individual who does this is known as a sole proprietor. If this describes your current setup, you may want to consider adopting a more formal structure, such as a limited liability company, as your business continues to grow. The California LLC attorneys at Structure Law Group can advise you of the risks and rewards of such a move.

Legal Liability and Tax Considerations

The benefit of being a sole proprietor is that you generally do not need to file much if any legal paperwork. Any income or losses incurred through the business is simply reported on your personal tax return at the end of the year on your IRS Schedule C.

However, the downside to being a sole proprietor is that there is no legal separation between your business and personal assets. For instance, if a business creditor sues you for an unpaid bill, they could attach a lien to your house or go after your other personal assets. As far as the law is concerned, you and your business are one and the same.

That is why changing your business structure from a sole proprietorship to a limited liability company can be beneficial. Unlike a sole proprietorship, an LLC is a legal entity distinct from you. The LLC can enter into contracts under its own name; therefore, you are not personally liable for any business debts.

At the same time, an LLC serves as a pass-through entity for tax purposes. This means that you will report any income or losses from the LLC on your personal tax returns, the same as you did while a sole proprietor. The IRS essentially “disregards” the existence of the LLC for tax purposes, even though you still retain the liability protections.

The Steps in Forming a California LLC

Creating an LLC in California is fairly straightforward. You must file an Articles of Organization form with the Secretary of State’s office. These Articles provide basic information about the LLC, including the name of the LLC, your business address, and who will accept legal service of process on behalf of the LLC. You will also need to file a Statement of Information within 90 days of registering your Articles of Organization, and every 2 years thereafter.

Once you form your LLC, you must transfer any business assets from your sole proprietorship to the LLC itself. This is normally done by creating and signing an LLC Operating Agreement. The Agreement is a contract between you and the LLC, in which you exchange assets for your membership interest.

Several additional steps are often need to be completed after changing a sole proprietorship to an LLC, including obtaining a separate tax identification number and re-applying for certain professional licenses in the name of the new entity. Our California limited liability company attorneys can advise you further in this area. To speak with an attorney, contact SLG today at (408) 441-7500 to schedule a consultation.