Are you ready to start your food business? If so, you might want to think about transitioning your business to a limited liability company, or LLC. Transitioning your business from a sole proprietorship to an LLC is important because as your business expands, you will need a greater level of legal separation between your personal and your business affairs. In this article, we will talk about sole proprietorships, LLC’s, why you should transition your business to an LLC, and the steps needed to transition your business to an LLC.
What is a sole proprietorship?
Sole proprietorships are the most common business structure in the U.S., and the most popular structure for small business owners. It is a type of unincorporated business that is owned and run by one person. It’s most likely that you have a sole proprietorship for your food product, as it’s the default entity for a standard business.
However, a sole proprietorship is not the only type of business structure that can work for you, as an LLC is another type of business structure that works well for growing businesses.
What is an LLC?
An LLC is a business that behaves like a corporation at the state level, but is taxed like a partnership or sole proprietorship at the federal level. An LLC is like a corporation because it gives business owners limited liability, which happens by separating your personal and business finances. This prevents your business from getting sued or going bankrupt.
An LLC is also like a sole proprietorship because LLC’s avoid double taxation. This means that, like a sole proprietorship, an LLC avoids getting taxed when the business earns income, and then again when profits are distributed to owners. Instead, the profits (or losses) of an LLC are taxed once on the owner’s personal tax returns.
Overall, an LLC is a business structure that allows small businesses to separate their personal and business assets, giving the business owners more financial protection than a sole proprietorship.
Why Convert to an LLC?
If you started your food business on the side while working a full-time job, your business is likely a sole proprietorship. However, as your business grows, so does the need to keep your business and personal finances separate. Transitioning to an LLC is a natural progression for your business because an LLC can limit your level of personal liability if your business incurs debts or is sued.
Before we jump into the process of transitioning from a sole proprietorship to an LLC, let’s take a look at how the two business structures differ.
Sole proprietorship vs. LLC
A sole proprietorship and LLC have differing requirements that allow them to provide certain advantages and disadvantages to your business. Below is a brief summary of each.
A sole proprietorship:
- Doesn’t require you to separate business and personal assets.
- Doesn’t have any legal separation between the business entity and its owner.
- Doesn’t require a business name, a separate business bank account, or any formal paperwork to create. (However, if you use a business name different from your legal name, also known as a DBA, your state may require a fictitious name filing.)
- Doesn’t require you to pay unemployment tax on your own income, although it is required if you have an employee.
- Can put you at risk for unlimited liability in the event of debts, losses, and liabilities, so you could lose your personal assets (home, car, etc.) in order to cover these payments.
- Has franchise fees and taxes that vary by location and are charged in addition to state and federal income tax, so changing to an LLC is not guaranteed to lower your tax bill.
- Can protect your assets if your business is sued or incurs debts.
- Requires you to separate business and personal assets. Otherwise, mixing the two would not protect you with limited liability (also known as “piercing the corporate veil”).
- Requires an operating agreement or articles of organization, a business name with “LLC” in it, and a designated bank account.
Deciding to transition from a sole proprietorship to an LLC will take some time and effort. You can read more about the differences between the two here.
How to transition from a sole proprietorship to an LLC
If you think your business is ready to transition from a sole proprietorship to an LLC, follow these steps:1. Consider professional assistance.
If you don’t have the time to change your business to an LLC, or you’d like some extra help, one option is getting assistance from an attorney or online services such as LegalZoom. An attorney can help provide personal assistance, but it will be more expensive. Online services can guide you through the process for a smaller fee.2. Choose a name for your LLC.
All states require that an LLC business’ name reflects the LLC status. Choose a name that includes “Limited Liability Company,” or the abbreviation of it (LLC). LLC name requirements vary by state.3. Designate a registered agent.
A registered agent is a person or business that accepts tax and legal documents on behalf of your business. Your registered agent will be your LLC’s main point of contact for the state and other legal authorities. You can be your own agent or have your attorney take on this role.4. File the articles of organization.
Your articles of organization should include basic information about your business. This includes your business name, address, registered agent, and the names of your members.5. Register with the IRS.
For taxes, an LLC can be treated as a corporation, partnership, or as a disregarded entity (the income would be included on the owner’s tax return). You can stick with the default IRS classification or choose a different option using Form 8832.6. Re-apply for licenses for the new LLC structure.
The regulations for business licenses vary by state, industry, and locality. The Small Business Association Licenses and Permits Tool can help you determine what licenses you need.7. Talk to your insurance company.
Get in touch with your insurance provider and notify them that your business structure is changing. They can also advise you on whether or not you need to purchase a new business insurance policy.8. Update your bank information or open a new account.
It’s likely that you will need to open a new business bank account for your LLC. At the very least, you will need to update your business bank information to reflect your new LLC status.
If you open a new account, you will need to close the old one. When doing so, stop using the account and change the banking information for any automatic payments.
Knowing the differences between an LLC and a sole proprietorship is essential for understanding which model will best benefit you as your company expands. Operating as an LLC will provide a greater level of legal separation between your personal and your business affairs, and protect you with limited liability. This article will serve as a guide for whenever you decide to change your business to an LLC model.