Many small businesses start as a sole proprietorship. After all, this is the default business structure. If you are a sole proprietorship and have never filed official training documents with the state, you are acting as a sole proprietorship.
There comes a time when a sole proprietor wants to formalize the business. Perhaps you have realized that your side hobby is now a legitimate and successful business. You may have realized that operating as a sole proprietorship puts your savings and personal assets at risk if your business were to incur debt or be sued. Or maybe you want to hire a new client that requires you to operate as an LLC or corporation.
Whatever the reason, the bottom line is that it is affordable and relatively easy to start a limited liability company (LLC). And, there won’t be a lot of changes in the way you operate your business. On the positive side, the LLC puts the separation between your business and your personal assets and you will have more flexibility in how your business is taxed. You can even change your perception of your business and feel more motivated to watch it grow.
If you want to start an LLC, here is the general process. Note that details vary by state, but these six steps will give you a general idea of what to expect.
Go from sole proprietor to LLC
1. Do some research to make sure your business name is available in your state
Let’s say Jane wants to form an LLC for her business, Jane’s Candies. She needs to make sure that there is not already another business called “Jane’s Candies” registered in her state. To check the availability of a name, you can contact the Secretary of State in your state (some states have an online searchable database). Another option is to have an online legal deposit service do the research for you – and many sites will offer this basic research for free.
2. File articles of incorporation with your state government office
The next step is to file specific documents, often referred to as an organization’s constitution, with your state office. The document is simple and you will need to provide information such as:
- The name and address of your LLC
- The purpose of your LLC. You usually don’t need to be specific here, and you can even give a general answer like “The purpose of a limited liability company is to engage in any lawful activity for which a limited liability company can be organized in.” this state “.
- The name and address of your registered agent (this is the person designated to receive the official papers of the LLC).
- An indication of your management: will your LLC be managed by members or managed by managers?
3. Create an LLC operating agreement
While LLC is a great choice for business owners looking for increased personal protection with less paperwork, paperwork is still required. Some states require LLCs to create an operating agreement. This document is a formal contract that defines the management and ownership of the LLC. It can describe details such as the share of the company that each member owns, the voting rights of each; how profits and losses should be distributed among members; and what happens when someone wants to leave the company.
The operating agreement may be only a few pages long, and you can find a few examples on the web. Even if your state does not require an operating agreement, it can be an important document to help clarify verbal agreements and avoid misunderstandings.
4. Register with the IRS
When you create an LLC, you must apply for a new EIN (Employer Identification Number) from the IRS. This is probably true even if you already had an EIN as a sole proprietorship. You can request an EIN here. The EIN is used to open business bank accounts, file taxes, manage payroll, and obtain business credit.
5. Request a new bank account
If you had a professional bank account for your sole proprietorship, you will need to close that account and open a new one in the LLC’s name (and with your new EIN number). Now that you are an LLC, you will need to maintain a clear separation between your business and personal finances. This will help protect your personal business assets – and has the added benefit of streamlining your business records for tax reporting.
6. Apply for business licenses and permits
Don’t forget about the licenses and permits required to legally operate your business, such as a professional license, reseller’s license, or health department permit. Some states require you to reapply for a license when your business structure changes. You can contact your local office or a site like BusinessLicenses.com to find out your specific licensing requirements.
That’s it. With these six basic steps, you have now formalized your business activities into a formal business structure.
If you are wondering what comes next… you can choose to be taxed as an individual while completing Schedule C and Schedule SE as you did as a sole proprietor. Or check with your CPA / tax advisor to see if there is a better tax strategy, since you now have more options as an LLC than you had as a one-stop-shop.
Finally, you will have to maintain your LLC, or you could end up losing your personal liability protection. Check out what your state’s maintenance requirements are, as you’ll usually have to file an annual report (it’s a very simple form) and pay a nominal fee.
Good luck with your business and congratulations on taking this important step towards building a solid foundation for your new business.
IT LLC Photo via Shutterstock