Converting a Sole Proprietorship to an LLC

A sole proprietor–an individual who owns a business directly (without any business entity)–is fully liable for all of the debts and obligations of the business.  For example, if an employee of a sole proprietor injures someone while driving a vehicle on company business, the sole proprietor is fully liable for the damages caused by such employee.  That means the sole proprietor’s personal assets (home, bank account, IRA account, etc.) could be taken to satisfy a judgment obtained by the injured person.

A limited liability company (LLC) could help protect the sole proprietor.  An LLC is recognized as a separate entity under the law and can help shield the owner of the LLC from the debts of the business.

If the sole proprietor were to transfer his entire business into an LLC which he owns and then operate the business out of LLC form, the LLC owner’s personal assets would not be subject to the debts of the business, except for contractual liabilities (where the owner signed personally) and except for liabilities caused personally by the owner.

Another significant advantage of putting a sole proprietor business into an LLC is that having the business assets owned by an LLC will facilitate the transfer of the business at the death of the owner.  Where a business is owned by an LLC, the transfer of ownership of the business is very simple at the death of the owner, merely necessitating a transfer of one document: a document assigning the LLC interest to the new owner or other heirs of the deceased.

In contrast, when a sole proprietor dies, each asset must be separately transferred to the heir or designated survivor of the deceased. The same is true in dealing with each debt of the business. It is far simpler to have a single-owner business owned by an LLC than by direct ownership of a sole proprietor.

With an LLC owning the business, income taxes do not enter the picture. If the business person owns 100% of the LLC, the LLC itself will not pay any federal or state income taxes or file any federal or state income tax returns.  Instead, all income, gains and deductions will be reported directly on the owner’s personal income tax returns. Due to such 100% ownership, the LLC in such situations is referred to as a “disregarded entity” for tax purposes.  This is another significant advantage for utilizing an LLC to limit potential liability while, at the same time, keeping tax return preparation and reporting very simple.

To properly utilize an LLC in a business setting, and to fully obtain the benefits an LLC has to offer, advice from a competent lawyer is needed.