This post was originally published Sep 29, 2015 and extensively updated November 25, 2019.
Starting a business requires courage, planning, hard work, and determination. As a business owner, you know that. You can’t trade in the security of a regular paycheck for the uncertainty of entrepreneurship if you don’t have fortitude.
With that being said, entrepreneurs commonly strike out on their own if they have not chosen a formal business structure for their company. There’s nothing wrong with that, but a question we at Cook Martin frequently hear asked in relation to this is:
Should I change from a sole proprietor to an LLC?
It’s an important question to ask and one we’re happy to answer. Sole proprietorship can be successful and there are some advantages associated with owning one. However, there are risks as well, and weighing a sole proprietorship vs. an LLC requires some knowledge and guidance.
We understand that choosing the right structure for your company can have lasting implications. Here’s what you need to know about changing from a sole proprietorship to an LLC in Utah.
What Is a Limited Liability Company?
A limited liability company is a simple business structure that can be used as protection from personal liability for expenses arising from your business operations. Currently, all 50 states allow sole proprietors to organize as LLCs.
The concept of the LLC statute is that the owner (technically referred to as a “member”) does not have any liability for business debts because they are a member or owner of the business. In other words, the owner or member has their personal assets separate so they are protected from claims arising out of the normal business operations. With this, it is understood that the protection of the LLC does not relieve the member of responsibility for their personal actions, nor will it protect them from and personal debts.
The Benefits of Organizing Your Business as an LLC
There are significant benefits to changing your sole proprietorship to an LLC. You’ll retain the freedom and flexibility you need to run your business while gaining some essential protections for you and your personal assets. Here are some of the LLC benefits you should know about:
- You’ll have liability protection to shield you from the actions of your employees. As a sole proprietor, an employee who behaves inappropriately or carelessly may put your personal assets at risk. With an LLC in Utah, as well as the other states, that risk goes away because it separates your personal assets from the company.
- In regards to the tax implications of switching from a sole proprietorship to an LLC, you won’t need to change the way you report your business activities to the IRS. The IRS allows sole proprietors who form an LLC to continue reporting their income on Schedule C of Form 1040. There are no additional filings required.
- There is less paperwork involved when forming an LLC in comparison to a You’ll need an Operating Agreement even if you are the LLCs sole member. If there are multiple members, you’ll need to specify each member’s ownership stake in the business. In addition, information will need to be included about how and when the LLC structure may be changed.
- Compared with limited partnerships, LLCs in Utah have more flexibility in how they distribute their profits. That gives you the option of profit sharing with minority members at a level you feel is appropriate.
The most important benefit is that the LLC structure offers you protection, so that your personal assets aren’t put at risk if someone sues your company.
The Risks of Organizing as an LLC
In many cases, switching your sole proprietorship to a limited liability company makes sense. That said, there are some risks associated with this business structure. Here’s what you need to know:
- Incorporating as a Utah LLC doesn’t exempt you from paying self-employment taxes. You’ll still need to contribute to Medicare and Social Security, paying both the employer’s and the employee’s portions of those taxes. As a result, your personal tax liability will be higher than it would be if you formed a corporation.
- LLCs only last while all members remain active and living. If a member leaves or dies, the LLC becomes invalid. You will then need to reincorporate your business, which can be time-consuming and expensive.
- The roles of LLC members in Utah are not clearly defined by the structure of the LLC the way they would be with a corporation. It’s important to specify roles in your Operating Agreement to avoid confusion and disruption. Having this clearly defined will lead to a smoother running LLC, where each member knows exactly what they should and should not be doing. This may seem time-consuming upfront, but will be beneficial in the end,
Provided you understand the risks and where possible, take steps to mitigate them, then changing your company from a sole proprietor in Utah to an LLC structure can be beneficial.
When to Switch from a Sole Proprietorship to an LLC
When should you consider switching from a sole proprietor to an LLC in Utah? This is a question that only you know the answer to, but we can give you some advice on signs that might indicate it is time to make the change.
- Your business carries a high degree of liability risk. With a sole proprietorship, you don’t have anything to shield your personal assets from claims against your company. That means you could lose your savings or even your home if someone sued you and won.
- You want to share profits with somebody or bring on a partner, and you want more flexibility than you would have with a Limited Partnership.
- It’s close to the end of the year and you want to avoid the tax complications of switching corporate structures mid-year.
You may decide that your business is low risk and you don’t need to change from a sole proprietor to an LLC. If that’s the case, you may want to consider buying liability insurance to get protection for yourself.
How to Switch from a Sole Proprietorship to an LLC
If you want to protect your personal assets by switching to an LLC in Utah, here are the simple steps to follow to make the change.
- Do a business name search in Utah to ensure that the business name you want to use is available. The website for the Secretary of State’s office is where you will be able to search business names and also begin the process of switching. Remember that the name must include “LLC” or “Limited Liability Company.”
- Appoint a Registered Agent for your new LLC.
- File an Organization Certificate in Utah and pay the $70 fee. If you want to expedite the process, you can pay of fee of $75 instead of the $70.
- Draft an Operating Agreement to specify the ownership percentages and roles of each member, as well as guidelines for resolving disputes and dissolving the LLC.
- Register with the IRS and get a new Employer Identification Number (EIN). You’ll need to do this even if you already had an EIN for your sole proprietorship.
- Open a new bank account for your LLC. Even though you’ll be paying self-employment taxes in most cases, it’s still a good idea to keep your business and personal expenses separate, especially if you have other members who share ownership of the LLC.
- Apply for any necessary Utah business licenses and permits. For example, in most cases, you’ll need to get business licenses in the name of your new company.
- Make sure that your letterhead, business accounts, business cards,, business licenses, advertising, and everything else related to your business is in the name of your new limited liability company. This consistency offers you additional protection and ensures that the lines between your business and personal dealings won’t be blurred.
We strongly recommend getting a lawyer to help you fill out the state forms properly and draft your Operating Agreement. You can find boilerplate agreements online, but it’s best to have an agreement that’s been reviewed by an expert and covers all possible contingencies. Your Operating Agreement should be signed by all members, notarized, and filed with the state.
How to Switch from an LLC to a Sole Proprietorship
Is it ever a good idea to switch from an LLC to a sole proprietorship? In some situations, it may be. For example, you might lose an LLC member and decide that you want to go back to being in business alone.
Making the switch from LLC to sole proprietorship for your business in Utah is entirely up to you and if you feel that it is time to do so then follow the these next steps:
- Close all the business tax accounts that have the LLC company name on it.
- Fill out and submit the forms to formally dissolve the LLC in the state of Utah. This can only be done by submitting the forms through the mail.
- File your sole proprietorship with Utah with the business name that you have chosen to use.
- Obtain any licenses and permits that may be required.
- Get a new EIN for your business.
- Make changes to your letterhead and other business materials.
If you are currently doing business as a sole proprietor, then switching over to a limited liability company is something that you may want to consider. You might currently think that there’s little chance of losing your personal assets as the result of a business issue when having a sole proprietorship, but incorporating as an LLC provides assurance that it won’t. For most proprietors, the advantages of the limited liability protection far exceed the cost of converting to an LLC. With that being said, there are always ways to make the switch back to a sole proprietor business structure if that ultimately works better for you and your business.
You’ll need to work with your lawyer to make the conversion from a sole proprietorship to an LLC and vice versa, but your accountant at Cook Martin Poulson, P.C. will be able to help you identify liability threats and provide insight as to whether the conversion is in your best interest.