How to Change Sole Proprietorship to LLC – Your Guide to a New Business

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Tom Smery

Tom Smery is a certified CPA for over a decade. In his free time, he writes articles to pass on his expert knowledge on taxes and accounting. Thomas has a wide range of deep knowledge on 1099 taxes, and finance topics. You can find him fishing when he is not preparing taxes for his clients or writing about accounting.

Most freelancers start their work as sole proprietors, but at some point, they might want to learn how to change sole proprietorship to LLC. Their client pool is growing, the business is more widespread - so, a change is due at this point.

But can you change from a sole proprietorship into LLC? How difficult would it be to do that? Are there any steps that you'll have to take with the IRS? Read on, and you'll find the answers to your questions.

Note: If you are a sole proprietor who wants to manage invoicing, proposals, contracts, and freelance taxes (in one spot!), then try Bonsai. Our easily editable templates and business expense tracker can help you take the stress away from your self-employed business and make your life easier. Try a 14-day free trial today.

Can a Sole Proprietor Be Under an LLC?

This depends on a variety of factors, such as the nature of your business as well as the state that you are active in. For instance, certain states will not allow certain types of licensed practitioners (i.e., lawyers) to set up an LLC. They'll need to set it up as a different type of business altogether.

Other states may allow sole proprietors to become LLCs even with these conditions - but there might be certain limitations. For instance, their personal property may not be protected from malpractice claims or bankruptcy, and they may experience personal losses from it.

So, it is important to check with the laws of your state. In most cases, there should be no reason why a sole proprietor can't change the nature of their business. Basically, they will be formalizing their business, filing paperwork just like they would be starting their LLC from scratch.

Why Should I Change from Sole Proprietorship to LLC?

One of the main benefits of opening an LLC versus staying a sole proprietor is that it gives you limited liability protection. When you are a sole proprietor, all your personal assets are tied to your business. Therefore, if your business goes bankrupt or you face a lawsuit, they have every right to seize your personal assets (i.e., your car, your house) to pay your debt.

This is not the case with an LLC. With the offered limited liability protection, your personal assets are not subjected to being seized. Your business and personal assets are held separately. So, in case something goes wrong with your business, at least your personal property will be safe. A sole proprietor isn't required to have a business bank account.

With LLCs, there is also a much lower chance for your business and personal finances to get mixed up. You'll have a new bank account, so when tax time comes, you will know exactly which expenses are connected to your business. It will also be helpful in terms of limited liability.

Last but not least, when you change your sole proprietorship to an LLC, you will be gaining more credibility. LLCs are ranked higher on the business scale, so the chances are that your potential clients will have a better impression of you.

How Hard Is It to Change from Sole Proprietorship to an LLC?

A benefit of a single incorporated business is it is super simple to transition to other business structures.

Generally speaking, changing from a sole proprietorship to an LLC is nothing different from starting the LLC from scratch. You will have to file the same paperwork as someone who is having their first attempt at running the business.

The only difference is that, depending on the state that you are in, you may have to close your old sole proprietorships and the associated business bank accounts. If you don't, there will be confusion, as you will be personally liable for two businesses - one of which is no longer in use. This action may take some extra time from your hands.

When Should I Turn My Sole Proprietorship Into an LLC?

Usually, when the time comes to change from your sole proprietorship to a single-member LLC, you will see a couple of signs. Here are the moments that tell you it's time to make the switch from a sole proprietorship to an LLC:

You Want Personal Liability Protection

As the sole owner, you are personally liable for everything that goes wrong with your business. If you love a lawsuit, the court can seize your personal assets such as your bank account, your home, your car, and everything you own.

However, by setting up a new LLC in place of your sole proprietorship, you receive personal liability protection. In these circumstances, they will only be able to access your LLC bank account.

Your Tax Burden Is Getting Too High

For a sole proprietorship, the self-employment tax and other income taxes might become slightly vexing. However, if you open an LLC, some of those tax burdens may be lowered.

You Are Planning to Get Business Funding

Sole proprietorships typically have issues when it comes to business funding. This is because most creditors are reticent to lend to this type of business owner.

However, as the owner of an LLC, you will seem more professional - ergo, you will be more likely to get that credit or loan that you needed.

You Want More Credibility

Customers are always looking for professionalism, so they are more likely to hire someone who has a formal business entity. Starting a separate legal entity under the LLC label might bring more clients.

If you want to reap these benefits of an LLC, then transition from a sole proprietorship.

How Do I Change from Sole Proprietor to LLC?

Changing from sole proprietorship takes a few steps that you have to be careful about (even deciding on incorporating or LLC). Here are some tips and considerations that you should keep in mind:

Professional Assistance Is Helpful

Setting up an LLC can have quite a few hoops and complications, and getting lost in the paperwork is a great possibility. This is why you might want to first look into some legal professionals to help you through the process.

Cancel the Sole Proprietorship

This may depend on the state that you are in, but in most circumstances, you need to cancel your registered sole proprietorship if you want to open an LLC. This is usually the case when you want to operate under the same business name. Check with your state regulations and see exactly where you fit in.

Choose the Name

As a sole proprietor, you would have your own name as the name of the business. However, with an LLC, you need a business name that ends with Limited Liability Company (or LLC). You may choose your own name to begin with, or you may decide on a different company name.

Choose a Registered Agent

Each LLC will need a registered agent that will act as the main point of communication between your business and the authorities.

You can choose to be your own registered agent, or you may have someone else do the job for you. In most cases, it's your attorney - and if you don't have one already, you can always hire someone from a law firm.

File Your Certificate of Incorporation

When setting up an LLC, there are certain pieces of paperwork that you will have to file. For starters, you have your Certificate of Incorporation or Formation, which you will need to file with your Secretary of State. You will need to pay a filing fee for this as well.

Draft Your Operating Agreement

When you are setting up your LLC, you also have to draft an LLC operating agreement. This will outline just how well you plan on running your LLC. It is a long-term technical business plan for your LLC.

Register Your LLC with the IRS

As a business owner, the IRS sees your work like any sort of corporation. You get profit from your business, and hence, you need to pay taxes. Applying for an EIN (Employer Identification Number) is one important step in registering with the IRS.

Pay Your Tax Obligations

After registering and filing all of your legal documents, you need to pay all of your tax obligations. Several tax types are concerned here, such as your annual minimum tax, your filing procedures and your additional taxes. Different states will have different tax obligations, so make sure that you are aware of what yours are.

Re-Apply for Your Business Licenses

Sole proprietor and freelancer business licenses are different from those with an LLC. So, if you are changing your business structure, you need to re-apply for all the licenses.

These licenses may differ based on the state or city. Depending on the type of business that you are running, you may need to get a zoning permit as well.

Contact Your Insurance Company

When changing from a sole proprietorship to a limited liability company, you need to contact your insurance company. Depending on the changes that you are making, you may have to buy a different business insurance company. Even if you don't need to change your policy, they'll still need to put your new information down.

Update Bank Information

Most sole proprietors will just use their personal bank accounts to make and receive payments, not bothering to set up a separate bank account. However, when you open an limited liability company, you will need a new LLC business bank account and business credit card - these must be intended solely for your LLC. If you also used a separate business account for your old business, make sure that you close the old one (after your last payments go through).

The Bottom Line

Changing from a sole proprietorship to LLC is relatively easy, as long as you follow the steps. You might want to hire an attorney for some of the technicalities, but for the most part, it should be just like starting a new business from scratch.

What Defines a Verbal Contract?

A verbal contract (formally called an oral contract) refers to an agreement between two parties that's made —you guessed it— verbally.

Formal contracts, like those between an employee and an employer, are typically written down. However, some professional transactions take place based on verbally agreed terms.

Freelancers are a good example of this. Often, freelancers will take on projects having agreed on the terms and payment via the phone, or an email. Unfortunately, sometimes clients don't pull through on their agreements, and hardworking freelancers can find themselves out of pocket and wondering whether a legal battle is worth all the hassle.

The main differences between written and oral contracts are that the former is signed and documented, whereas the latter is solely attributed to verbal communication.

Verbal contracts are a bit of a gray area for most people unfamiliar with contract law —which is most of us, right?— due to the fact that there's no physical evidence to support the claims made by the implemented parties.

When is a Verbal Agreement Legally Binding?

For any contract (written or verbal) to be binding, there are four major elements which need to be in place. The crucial elements of a contract are as follows:

Offer and acceptance: An offer is made and accepted by another party involved in the agreement;
Consideration: The involved parties must exchange something of value (money, a service, time, etc), this is known as consideration;
Intention and certainty: All parties must fully understand the terms of the contract and intend to make a legally binding agreement freely; and
Capacity: The parties must have the capacity to legally enter into the contract; they're above age and of a stable mindset.

Therefore, an oral agreement has legal validity if all of these elements are present. However, verbal contracts can be difficult to enforce in a court of law. In the next section, we take a look at how oral agreements hold up in court.

How strong is a verbal agreement in court?

Most business professionals are wary of entering into contracts orally because they can difficult to enforce in the face of the law.

If an oral contract is brought in front of a court of law, there is increased risk of one party (or both!) lying about the initial terms of the agreement. This is problematic for the court, as there's no unbiased way to conclude the case; often, this will result in the case being disregarded. Moreover, it can be difficult to outline contract defects if it's not in writing.

That being said, there are plenty of situations where enforceable contracts do not need to be written or spoken, they're simply implied. For instance, when you buy milk from a store, you give something in exchange for something else and enter into an implied contract, in this case - money is exchanged for goods.

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When are verbal agreements not enforceable?

There are some types of contracts which must be in writing.

The Statute of Frauds is a legal statute which states that certain kinds of contracts must be executed in writing and signed by the parties involved. The Statute of Frauds has been adopted in almost all U.S states, and requires a written contract for the following purposes:

The sale of real estate or vehicles
Real estate leases lasting longer than one year.
Property transfer following the death of the owner.
The case of a party agreeing to pay debt for someone else.
Any contract that requires more than a year to fulfil.
A contract involving and exceeding a specified amount of money (which varies by state).

Typically, a court of law won't enforce an oral agreement in any of these circumstances under the statute. Instead, a written document is required to make the contract enforceable.

Contract law is generally doesn't favor contracts agreed upon verbally. A verbal agreement is difficult to prove, and can be used by those intent on committing fraud. For that reason, it's always best to put any agreements in writing and ensure all parties have fully understood and consented to signing.

How are Verbal Contracts Enforced?

Verbal agreements can be proven with actions in the absence of physical documentation. Any oral promise to provide the sale of goods or perform a service that you agreed to counts as a valid contract. So, when facing a court of law, what evidence can you provide to enforce a verbal agreement?

How can you prove an oral contract?

Unfortunately, without solid proof, it may be difficult to convince a court of the legality of an oral contract. Without witnesses to testify to the oral agreement taking place or other forms of evidence, oral contracts won't stand up in court. Instead, it becomes a matter of "he-said-she-said" - which legal professionals definitely don't have time for!

If you were to enter into a verbal contract, it's recommended to follow up with an email or a letter confirming the offer, the terms of the agreement , and payment conditions. The more you can document the elements of a contract, the better your chances of legally enforcing a oral contract.

Another option is to make a recording of the conversation where the agreement is verbalized. This can be used to support your claims in the absence of a written agreement. However, it's always best to gain the permission of the other involved parties before hitting record.

Written vs Verbal Contracts: What's the Verdict?

Fundamentally, most verbal agreements are legally valid as long as they meet all the requirements for a contract. However, if you were to go to court over one party not fulfilling the terms of the contract, proving that the interaction took place can be extremely taxing.

So, ultimately, the question is: written or verbal agreements?

Any good lawyer, contract law firm, or legal professional would advise you to make sure you formalize any professional agreement with a written agreement. Written contracts provide a secure testament to the conditions that were agreed and signed by the two parties involved. If it comes to it, a physical contract is much easier to eviden in legal circumstances.

Freelancers, in particular, should be aware of the extra security that digital contracts may provide. Many people choose to stick to executing contracts verbally because they're not sure how to write a contract, or they think writing out the contract terms is too complicated or requires expensive legal advice. However, this is no longer the case.

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Say hello to digital contracts

Today, we have a world of resources available at our fingertips. The internet is a treasure trove of invaluable information, platforms, and software that simplifies our lives. Creating, signing, and sending contracts has never been easier. What's more, you don't have to rely on a hiring a lawyer to explain all that legal jargon anymore.

There are plenty of tools available online for freelancers to use for guidance when drafting digital contracts. Tools like Bonsai provide a range of customizable, vetted contract templates for all kinds of freelance professionals. No matter what industry you're operating in, Bonsai has a professional template to offer.

Benefits of written contracts

A written contract makes the agreement much easier to prove the terms of the agreement in case something were to go awry. The two parties involved can rest assured that they're legal rights are protected, and the terms of the contract are sufficiently documented. Plus, it provides both parties with peace of mind to focus on the tasks at hand.

Create Professional Contracts with Bonsai

Bonsai's product suite for freelancers allows users to make contracts from scratch, or using professional templates, and sign them using an online signature maker.

With Bonsai, you can streamline and automate all of the boring back-office tasks that come with being a freelancer. From creating proposals that clients can't say no to, to sealing the deal with a professional contract - Bonsai will revolutionize the way you do business as a freelancer.

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