Going from Sole Proprietorship to LLC: When and Why

Most solopreneurs start as sole proprietorships. Of the top four types of business structures in the United States, sole proprietorships account for 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 train and allow homeowners to keep tax and legal matters as simple as possible. However, as solopreneurs contemplate expansion, this simplicity becomes a double-edged sword. The simple rules of sole proprietorships leave little room for growth. At this point, switching to a limited liability (LLC) business structure can provide entrepreneurs with flexibility, tax advantages and asset protection.

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

1. Are you worried about your personal wealth?

With a sole proprietorship, you and your business are the same legal entity. This means that you are personally liable for your business debts and liabilities. personal property; such as your home or bank accounts; may be threatened 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 any debts or legal obligations of the company. (However, they are of course responsible for their own conduct and any personal financial commitment to the LLC.) As is always the case with risk, each entrepreneur will need to determine what type of protection makes them most comfortable. p>

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 an overlooked entity, which allows you to claim your business income on your personal return; just as you would in a sole proprietorship.

Alternatively, you can choose to tax your LLC as a corporation. For sole proprietors whose personal income tax rate is higher than the corporate tax rate, this can reduce your overall tax burden. This structure also reduces self-employment taxes for the individual since employers normally pay half the cost of Social Security and Medicare taxes. Keep in mind that if you choose to tax your LLC as a corporation, you will not be able to change status for 60 months (five years).

Sole proprietorships and LLCs can deduct business expenses from tax, including health and disability insurance costs, office supplies and utilities, and business vehicles and the mileage. LLCs that are taxed as flow-through entities may also claim qualified business income (QBI) deductions. This deduction, which was established by the Tax Cuts and Jobs Act 2018 and is available until 2025, allows self-employed and small business owners to deduct up to 20% of their income corporate taxes.

3. Do you plan to hire employees?

While sole proprietors can hire employees, operating as an LLC can make it easier to comply with employment and tax laws. Navigating employers' legal requirements and payroll taxes can be difficult, especially for a growing business. Since LLCs separate the operations and finances of the business from those of the owner, it can simplify the management of full-time employees. Additionally, LLCs provide protection against potential employee disputes.

4. Will you take a business partner?

If a partner joins your company, your structure automatically transforms into