Switching from a Sole Proprietorship to an LLC: When & Why to Do It

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ost solopreneurs start as sole proprietorships. Of the four main types of business structures in the US, sole proprietorships make up 86.6% of small businesses without employees. One of the reasons sole proprietorships are so popular among new entrepreneurs is their simplicity. They are easy to form and allow owners to keep taxes and legal matters as uncomplicated as possible.

As solopreneurs consider expansion, however, this simplicity becomes a double-edged sword. The straightforward rules of sole proprietorships leave little room for growth. At this stage, switching to a limited liability company (LLC) business structure can bring entrepreneurs flexibility, tax benefits, and asset protection.

But how do you know if it’s time to upgrade your business structure? Ask yourself these questions:

1. Are you worried about your personal assets?

With a sole proprietorship, you and your business are the same legal entity. This means that you are personally on the hook for the debts and liabilities of your business. Personal assets-;such as your home or bank accounts-;may be at risk to satisfy unpaid debts, legal judgments, or other obligations.

An LLC, on the other hand, is a separate entity from the business owner. LLC members are not personally liable for the company’s debts or legal liabilities. (Though, they are of course liable for their own conduct and any personal financial commitments to the LLC.) As is always the case with risk, each entrepreneur will need to determine what type of protection makes them the most comfortable.

2. Could you save money with a different tax strategy?

With sole proprietorships, you only have one option for how you are taxed-;your net business income is taxed on your individual tax return at your individual tax rates. You are also responsible for paying self-employment taxes.

LLCs, on the other hand, give their members the unique ability to choose how they are taxed. Solopreneurs can choose to be a pass-through entity, also known as a disregarded entity, which allows you to claim your business income on your personal return-;just like you would in a sole proprietorship.

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