Turning Your Business into an LLC

A male business owner sits at a wooden bar along a large window as he works on his laptop computer in a small business.

Most first-time entrepreneurs begin their businesses as sole proprietors. Registering one is relatively easy, and the taxes are straightforward when compared to corporations or partnerships.

But as your business grows and evolves, being a sole proprietor may introduce unnecessary risk to your personal finances. Incorporating your company can protect your personal assets, and create a distinct separation between you and your business.

Evaluate your business and consider whether creating a corporation makes sense.

Sole Proprietor vs. Corporation

As a sole proprietor, you and your business are the same entity in the eyes of the law. Instead of paying corporate taxes, you claim what you earn as personal income. The business structure is exceedingly simple. There are very few regulations and no extra work beyond following the federal and local guidelines for registering a business. However, the risk is that you and your business are the same. So if your business incurs debt or faces a liability—such as a lawsuit—then you’re the one responsible for it.

With a corporation, on the other hand, you and your company become two separate entities, even if you are still the sole employee of your company. You can choose between a few different types of corporations, depending on your business and needs:

  • S Corps are usually reserved for small businesses. They don’t pay corporate taxes but instead pay on dividend earnings.
  • C Corps require that you pay corporate taxes. However, they allow you to establish shares in the company. If you’re a startup, then a C Corp is a must-have for attracting investors.
  • LLCs, or limited liability corporation, protects your personal assets but offers some flexibility—depending on the state you live in—in terms of whether you pay corporate taxes.

When to Make the Change

First, you need to assess the risk of your business. Does your business activity inherently carry a significant amount of risk? For instance, are you working on or with other people’s property? Could a mistake on your part cost your clients money or negatively impact their business? If your business is relatively risky—or the risk has increased as you’ve grown—then you’ll want to incorporate it as soon as possible.

Alternately, examine your personal assets and determine if there are things you’d like to protect. Maybe it’s retirement savings or your home. If you’re concerned that your assets could be at stake, then moving away from a sole proprietor structure is smart.

As for when to make the change, consider that once you incorporate, you’ll need to pay corporate taxes. So if you operate your business as both a sole proprietor and a corporation in the same year, your taxes become complicated—and you could pay twice.

Ideally, make a clean break and incorporate it at the first of the year. However, as noted, if the risk of the business is high, then the tradeoff of limiting liability sooner rather than later (even if it means potentially more taxes) could be worth it.

Fifth Third's experienced business bank representatives can help you with planning and finding the most effective way to reach your business goals.

The views expressed by the author are not necessarily those of Fifth Third Bank, National Association, and are solely the opinions of the author. This article is for informational purposes only. It does not constitute the rendering of legal, accounting, or other professional services by Fifth Third Bank, National Association or any of their subsidiaries or affiliates, and are provided without any warranty whatsoever. Deposit and credit products provided by Fifth Third Bank, Member FDIC.