Perhaps you’ve started making a decent side income by selling handmade items on Etsy or baking on the weekends. Or you may have recently monetized your blog, and you have built a large following. Whether you realize it or not, your new source of income is a business. If you have yet to create a separate legal entity for your new business (and you are the sole owner), you are running your business as a sole proprietorship.
What does it mean to be a sole proprietorship? Essentially, YOU are the business. Every contract you sign, every transaction you make, and every debt you acquire, is personally guaranteed by you as an individual. In the event of any kind of default or lawsuit, your personal assets could be at stake.
Many new entrepreneurs delay converting their new business to an LLC or other legal entity due to intimidation and a fear of complicated tax structures. With the proper legal and tax guidance, it doesn’t have to be difficult at all. Here are 5 key steps to converting your sole proprietorship to an LLC, thereby gaining greater legal protection for yourself and your assets.
1. Check Name Availability
Before getting started, you will first want to make sure that the business name you have in mind (or have been using up to this point) is legally available. In Texas, your business may not bear a name that is the same or deceptively similar to the name of another entity (unless you receive consent). You can contact the Secretary of State here to find out whether or not the name you have in mind is available. If it is, but you are not quite ready to move forward with the LLC paperwork, you can file a Name Reservation with the Secretary of State, which will hold your desired entity name for up to 120 days, subject to renewal.
2. File Certificate of Formation with Secretary of State
To create a new LLC in Texas, one must file a Certificate of Formation with the Secretary of State. I highly advise consulting with a business attorney before submitting this paperwork in order to include the appropriate language and to avoid any costly mistakes. Once accepted and filed by the state, your LLC is officially in existence. You will receive a signed certificate of filing which provides an effective date and a filing number, all of which will be important to preserve on file for later use.
3. Execute a Company Agreement
Once your state documentation is complete, you will also need to execute a company agreement. This internal document should be drafted by a competent business attorney, as it will serve to govern how your company is managed, how the company is funded, how income shall be distributed, as well as all other internal business operations. LLC’s don’t require many corporate formalities, but a company agreement is definitely one of the most important. This document should be kept on file and regularly updated, if needed, in order to maintain your legal protection.
4. Register for FEIN and Open New Bank Account
All new businesses need to register for a Federal Employer Identification Number (even if you don’t have any employees) for tax identification purposes. This number will be used on all correspondence with the IRS and will be necessary for opening a new bank account in the name of the LLC. You may quickly and easily apply for a FEIN through the IRS website here. Bring all LLC documentation with you when opening a new bank account.
5. Consult with Your Tax Advisor and Transfer Assets and/or Accounts
Lastly, you will want to meet with your tax advisor to discuss different options for the taxation of your new business. Depending on whether or not you have one or more members, you may be taxed as a sole proprietor, a partnership, or you may elect to be treated as an S-Corporation. Additionally, your tax advisor can discuss options for transferring any funds, assets, or property from your name to the LLC, as each option may have different tax implications. Please keep in mind that from this point forward, everything should be signed and/or executed in the name of the LLC. You should transfer any current accounts you may have with other vendors, or otherwise, into the name of the LLC.
Please keep in mind that every business is different and it is important to consult with a competent business attorney before moving forward. It may seem intimidating, but once you have taken each of these steps, you will have set yourself and your business up for a positive future.