Sole Proprietor to LLC: New EIN, W-9, Bank and Taxes

Can you convert a sole proprietorship to an LLC?

Not directly. A sole proprietorship is a business you own alone without forming an entity (IRS), so there is nothing to convert. You form a new LLC with your state and move the business into it. The LLC exists from the date the state filing takes effect. For federal income tax, a one-owner LLC is ignored as separate from you (a "disregarded entity") unless it elects to be taxed as a corporation (IRS: Single-member LLCs).

The switch stops being routine when the business has employees on payroll, a spouse or partner will own part of the LLC, your state taxes LLCs (California and Texas do), you plan to elect S corporation status, or equipment carries loans. Gather your current EIN letter and payroll accounts, client contracts, licenses and permits, your sales tax account, insurance policies and a list of the equipment, vehicles and inventory you will move.

In what order should I switch things over to the LLC?

Form the LLC first, settle the EIN, open the bank account, then move everything that carries the business's name. The step-by-step formation guide covers the state filing itself.

Close old sole-proprietor accounts, such as sales tax and payroll, only after their last returns are filed; keep your own EIN active while clients still get it on your W-9.

Do I need a new EIN when my sole proprietorship becomes an LLC?

Not always. The IRS lets a one-owner LLC use your sole-proprietor EIN, or report under your SSN, as long as it has no employees, owes no federal excise tax (such as the tax on heavy trucks) and does not elect corporate or S status (IRS: Do you need a new EIN?). You file nothing with the IRS to keep this treatment: a one-owner LLC is disregarded by default (26 CFR 301.7701-3).

An EIN does not change how the LLC is taxed. For how to apply and which number goes where, see EIN for a single-member LLC.

What happens to my old EIN and to payroll if I have employees?

Your sole-proprietor EIN stays yours: the IRS never cancels an EIN, but deactivates it if you send a letter asking, once every return due under it is filed and its taxes are paid (IRS). Employees move to the LLC, because a one-owner LLC is a separate employer for employment tax and must report and pay wages under its own name and EIN (IRS: Single-member LLCs).

• The switch quarter: when a business is transferred mid-quarter, each employer files Form 941 for only the wages it paid (Form 941 instructions).
• The old account's last return: check line 17 on the final Form 941, enter the last date wages were paid, and attach a statement giving the LLC's name, its form of business, the kind and date of the change, and the name and address of whoever keeps the payroll records (Form 941 instructions). Check box d on the final Form 940 (Form 940 instructions). Forms W-2 for the old account's wages then go to employees by the final Form 941's due date, and to the SSA by the last day of the second month after that quarter, unless the LLC takes over the whole year's Forms W-2 for the employees it keeps (Rev. Proc. 2004-53). If the LLC does not count as a successor employer, the SSA copies are due by the final Form 941's due date too (Form W-2 instructions). If the LLC takes them over, both file Schedule D (Form 941) (instructions).
• Wage limits: the LLC may count as a successor employer, which lets it count wages already paid this year toward the yearly caps on social security and federal unemployment (FUTA) tax (Publication 15). If it does, it checks box b on its Form 940 (Form 940 instructions). Check this before the first LLC payroll.
• State payroll: report the entity change to your state; California, for example, takes it through its online employer account (EDD).
• You: a one-owner LLC is not your employer, so you do not go on its payroll; you keep paying self-employment tax (26 CFR 301.7701-2).
• Your own liability: the LLC owes its payroll tax, but withheld tax it does not pay over can be charged to you personally, at 100% of the unpaid amount, if you were responsible for paying it and willfully did not (Publication 15; 26 U.S.C. 6672). The IRS generally has 3 years from the April 15 after the payroll year, or from a later filing, to assess it (26 U.S.C. 6501). See trust fund recovery penalty.

Which W-9 do I give clients after forming a single-member LLC?

A one-owner LLC with no election puts your name on line 1 and the LLC's name on line 2, checks your own classification (individual/sole proprietor) on line 3a, not the "LLC" box, and gives your SSN (or ITIN) or your own EIN, not the LLC's EIN (Form W-9). The number must match the name on line 1; a mismatch can lead the payer to backup withhold 24% of payments (requester instructions).

Once the LLC elects corporate or S status, its own name goes on line 1 with its own EIN. In the switch year, some Forms 1099 may come in your name and some in the LLC's name; all of them belong on the same Schedule C (IRS: Single-member LLCs). If a payer reports under the LLC's EIN by mistake, see EIN for a single-member LLC.

What changes on my tax return after forming a single-member LLC?

For a one-owner LLC with no election, the federal return looks the same: Schedule C, with self-employment tax on the profit, as for a sole proprietor (IRS: Single-member LLCs). Because the business is the same before and after the LLC, one Schedule C generally covers the whole year.

• Line D: enter the LLC's EIN only if it was issued for payroll, excise or certain other returns, or a qualified retirement plan; an EIN the LLC got only for its bank does not go there (Schedule C instructions).
• Gross receipts: include every Form 1099 received, in either name.
• Self-employment tax: unchanged unless the LLC elects S or C corporation status.
• State return: some states make the LLC file its own return even though the IRS ignores it; California requires Form 568 every year (FTB).

Do I owe tax for moving equipment, vehicles or inventory into my LLC?

Generally no federal income tax, if the LLC has one owner and no election. Its activities are treated as yours, like a sole proprietorship (26 CFR 301.7701-2), so moving assets in is not a sale. Depreciation continues on the same schedule and basis.

State tax can differ. California warns that some ownership changes include taxable transfers of merchandise and asks owners to contact it first (CDTFA). Vehicle titles and loans may need the motor vehicle agency's or lender's sign-off. Moving the business into a corporation, or into an LLC with a second owner, is a different tax question: see changing your business structure.

What changes if a spouse or partner joins the LLC at the same time?

An LLC with two or more owners is a partnership by default (26 CFR 301.7701-3). From the date both own it, the business files Form 1065 (Form 1065 instructions), each owner receives a Schedule K-1, and the partnership needs its own EIN. Income earned before that date stays on the original owner's Schedule C.

Spouses who own an LLC as community property under state law may choose to treat it as disregarded or as a partnership; in other states a spouse-owned LLC files as a partnership (IRS: Single-member LLCs). See spouse and family LLCs.

Should my new LLC elect S corporation status now?

Not automatically. An S election adds payroll for you and a separate corporate return, so whether it pays off depends on your profit and the salary you must pay yourself. An LLC elects by filing Form 2553, without Form 8832, no later than 2 months and 15 days after the start of the tax year the election takes effect (Form 2553 instructions). For a new LLC, that first tax year starts on the earliest of the dates it first had owners or assets or began doing business, so the clock may already be running. A late election may still be accepted for reasonable cause, generally within 3 years and 75 days of the intended start date (Form 2553 instructions; late S corporation election relief). The election treats you as contributing the LLC's assets and debts to a corporation for its stock, which can create taxable gain if the debts exceed the assets' tax basis (26 CFR 301.7701-3; 26 U.S.C. 357). See whether an S election pays off and S corporation from day one.

What state costs start when I form an LLC?

A formation fee, and in many states a yearly report, fee or tax that applies to LLCs but not to sole proprietors. Two examples:

• California: every LLC organized or doing business in California pays an annual tax of $800, the first one due by the 15th day of the 4th month from the date it files with the Secretary of State, plus an LLC fee once its total California income reaches $250,000 (FTB). See California minimum tax and LLC fee.
• Texas: sole proprietorships are not subject to franchise tax, but single-member LLCs are. An LLC with revenue at or below the $2,650,000 no-tax-due threshold still files an information report each year (Texas Comptroller).

For every state's fee and due date, see LLC annual fees and reports by state.

Example

These examples are illustrative and use US dollars.

A photographer with no employees

A photographer forms a one-owner LLC in July. Her bank asks for an EIN, so the LLC gets one. Her W-9 shows her own name on line 1, the LLC on line 2 and her SSN. For the year she files one Schedule C showing $60,000 profit, January through December, and leaves line D blank because the EIN was not issued for payroll or excise returns.

A contractor with two employees

A contractor forms an LLC and gets its EIN. He pays his two employees under his sole-proprietor EIN in July and under the LLC's EIN from August. For the third quarter, the old EIN files a final Form 941 for July wages and the LLC files Form 941 for August and September. The old account files a final Form 940 for the year. Unless the LLC takes over the whole year's Forms W-2, each employee gets two: one from the old EIN for July, due by the final Form 941's due date, and one from the LLC for August onward. His income still goes on one Schedule C.

A designer and her business partner

A designer and her partner form an LLC on April 1, each owning half. January to March stays on the designer's Schedule C. From April 1 the LLC is a partnership: it gets its own EIN and files Form 1065. If it earns $80,000 by December and the owners split profit equally, each owner's Schedule K-1 shows $40,000.

Different for you?

• You have employees on payroll: moving them to the LLC's EIN mid-year needs final returns and wage-base checks; get business formation help.
• A spouse or partner will own part of the LLC: see spouse and family LLCs and get business formation help.
• You plan to elect S corporation status: the Form 2553 clock may start when the LLC does; see S corporation from day one and get business formation help before the deadline passes.
• Your state taxes LLCs: check LLC annual fees and reports by state and get business formation help before the first state return or payment is due.
• Your switch-year books are split across two names or accounts: get bookkeeping help.
• You are moving into a corporation, or assets carry loans: see changing your business structure.
• You are still deciding whether to form an LLC: see LLC or sole proprietorship and, if you are paid on 1099s, do independent contractors need an LLC.
• You are not a US citizen or resident: your LLC is treated as a corporation for Form 5472 reporting (26 CFR 301.7701-2) and you give clients a Form W-8, not a W-9; see foreign-owned single-member LLC filing and get cross-border tax help.
• Your business is in Canada: see the sole proprietor to corporation checklist.