Change an LLC to a Sole Proprietorship in 5 Steps

It’s no secret that an LLC is one of the most common business entity types for entrepreneurs trying to make it big by converting their passion into profit. However, running an LLC is much more complicated than being a sole proprietor.

Luckily, there’s a simple way to change an LLC to sole proprietorship, especially if you’re the LLC’s sole owner. It can relieve you from additional tax and reporting burdens and allow you to focus on growing your business more organically.

Key Takeaways

• The process of changing an LLC to a sole proprietorship involves dissolving the existing business.

• Business owners must follow precise filing and dissolution procedures to avoid getting fined or becoming liable for taxes unpaid by an improperly dissolved business.

• After you dissolve the company, you can start working as a sole proprietor with minimal filing requirements.

Sole Proprietorship vs. LLC

A sole proprietorship is the default informal business structure for individuals who provide services independently. Because it's an informal structure, it usually doesn't have to be registered with the state's Department of Revenue.

An LLC (limited liability company) is a pass-through business structure that can be run by one or more owners (called “members”). It’s legally a separate entity from the owner, but the income and taxes are processed (passed through) to the owners’ tax returns.

It’s the most common small business type in the U.S., with 99.9% of companies registered as LLCs, and roughly 70% of them are single-member LLCs.[1] 

Limited Liability

By default, a sole proprietor’s business is part of their personal assets. As such, any claim against you can result in remuneration against your personal property, such as your house or vehicle.

An LLC is a separate business entity with its own assets and liability protection. If a claim is made against you when you’re a company member, only the company’s assets can be claimed in a court of law.

Taxation

As a sole proprietor, you'll file a single tax return on your personal income to the Internal Revenue Service (IRS) each year. Your income is taxed under the personal income bracket for your state, plus any sales and excise taxes on your product.

If you run an LLC, the IRS considers the company a disregarded entity and passes its income to the members. If the LLC has multiple members, the income is divided according to the membership stake. The members are then subject to the same self-employment tax.

When operating an LLC, you can claim your business equipment, home office utilities or rent, travel expenses, and other business-related costs as business expenses in your tax return and get a deduction. However, even a single-member LLC is liable for franchise tax if the state requires it.

Administration

A sole proprietorship is an informal, unincorporated business. It doesn’t have to be registered with the state. However, you may need to obtain a business license to provide specific professional services.

An LLC needs licenses, must be properly registered with the state and the Department of Revenue, and most states require periodic business reports, typically annually. Additionally, the new Beneficial Ownership Information (BOI) report requirements mandate most LLCs to submit a yearly report on their ownership.

A business also needs to specify a registered address, enter the public record, and appoint a registered agent to receive documentation such as mail and service of process. A single-member LLC will usually need someone else to be their registered agent or hire a registered agent service to keep standard office hours. Otherwise, the business risks losing its good standing and may be fined.

When to Convert?

If your business has a low cash flow and minimal operation expenses, the tax benefits you gain from cost deductions are usually outweighed by the franchise tax and annual reporting costs. In that case, you can convert from LLC to sole proprietorship to stop paying unnecessary costs until the business picks up.

Alternatively, if you formed an LLC as part of a partnership and the other members left, it might be the only option available to you. Other reasons may include bankruptcy or forced dissolution by the state.

In general, the benefits of maintaining an LLC outweigh the costs so long as you have a steady source of income. However, it’s not for everyone, and you’ll need to calculate whether it’s worth it in the long run.

How to Convert an LLC to Sole Proprietorship

Converting an LLC into a sole proprietorship is technically not something you do as a business change or amendment. What you’ll need to do instead is dissolve the LLC. 

While that might sound daunting, all states have a straightforward legal LLC dissolution process. If you’re running a single-member LLC, the process to change LLC to sole proprietorship is usually going to be pretty fast.

1. Follow Your Dissolution Procedures

You have most likely drafted an LLC operating agreement during the formation procedure. That document should contain the procedure for dissolving the company or an event that triggers the dissolution.

If the dissolution is voluntary, members will typically need to vote on the decision to dissolve, and the operating agreement states whether a majority or unanimous vote is required to pass it. You may need to draft an official notice for internal records and record the vote alongside every member’s signature, signifying their approval.

When you do, you will need to let go of your employees. If the LLC is manager-managed, they are usually obligated to close all the business’s affairs before being let go of the management duty. Member-managed LLCs can elect a member to finalize the dissolution process.

If you run a single-member LLC with no employees undergoing voluntary dissolution, the process simplifies, only requiring drafting a written and signed notice that you’ve “voted” on dissolving the company.

2. File Articles of Dissolution

With the dissolution triggered by your operating agreement, you’ll need to contact the state.

This will depend on your Secretary of State or the appropriate Department or Division of Corporations. In most cases, your government’s website will have a link that you can use to access an online portal to proceed with the dissolution.

You will need to find the form for Articles of Dissolution or Certificate of Termination. The exact names of the forms you need depend on the state and can usually be found on the Secretary of State's website. Then, you will file that form and pay any filing fee. You won’t need to file an annual report for that year.

Some states require you to finish "winding up the company affairs" before filing for dissolution, while others require you to file the document and start the process. "Winding up" means that the company legally cannot perform any services or sell products and only exists to wrap up its existence.

You may need to file one document to start the dissolution process and another after you finish with the final payroll or taxes, close your accounts, and settle any other affairs. You will need to refer to the documentation and the Secretary of State's office or get legal advice from an attorney for the proper procedure.

You may need to publish the Certificate of Termination in a local publication. This requirement is county (or town) based, so you’ll need to check with the local clerk for more information.

Additionally, you will need to submit Confirmations of Withdrawal (or analogous documentation) to states where your company was registered as a foreign LLC.

3. Notify Creditors, Vendors, and Partners

As part of winding up the company affairs, you must notify all creditors, vendors, and other business partners, usually in writing. Additionally, you'll need to submit a notice to the creditors how long they can claim any outstanding debt or repay that debt.

Additionally, you will need to contact your registered agent (or registered agent service) and insurance provider. In some cases, a third-party registered agent service can start the dissolution process for you and should be contacted before filing any documentation to the state.

You may also want to alert customers and clients of your LLC’s dissolution

4. File Final Tax Returns on Federal, State, and Local Levels

Before your company can close for good, you will need to file a final tax return with the IRS.[2]

If your business has employees, you must pay them their final paychecks and pay taxes on those. Additionally, you will need to report any payments for suppliers exceeding $600.

Finally, you will need to send a letter to the IRS with the information relating to your business and the reason behind its termination, alongside the notice from the IRS on your EIN (Employer Identification Number) registration. When that is processed, your EIN is canceled, and the IRS will close your business account.

You can also close all business bank accounts.

5. Organize Your New Sole Proprietorship

With the LLC dissolved and all affairs settled, each member can go their separate ways to open a new business or remain as a sole proprietor.

Typically, the dissolution process triggered by the LLC operating agreement also requires all business assets to be transferred or liquidated and distributed among members. Asset transfers, particularly for real estate, might take a bit longer to settle before you can use the property.

If you decide to stay in business and provide the same services as before, you will need to do the following:

1. Obtain sales and professional business licenses as requested by the state departments. You may be able to transfer your previous licenses until they need to be renewed.

2. Get a new EIN from the IRS. You might not need an EIN if you don’t intend to (re)hire employees or don’t need to pay excise, alcohol, or tobacco taxes, among other things.

3. Register a DBA (doing business as) name. By default, a sole proprietor uses their legal name to conduct business, and some states require a DBA or trade name for all sole proprietors who intend to sell products or provide taxable services.

4. Open a new bank account to separate your business and personal finances.

5. Update your marketing materials, create a new website, and start your business as a sole proprietor.

The Importance of Proper Dissolution

Properly dissolving your LLC involves a lot of paperwork to let state and federal agencies know that the company is no longer functioning. Entrepreneurs should consult a corporate attorney for legal advice on how to proceed while obeying state law and minimizing the risk of mistakes. You are liable for any consequences if you don't wrap up the business's affairs.

For example, if the business is still registered with the state, you will need to submit an annual report and pay any annual fees. Even if the business technically doesn’t offer services or products, those taxes are transferred over to you and can be nearly impossible to annul. If the company owns properties, you won’t receive that real estate back until the LLC is dissolved and may need to continue paying its lease through company accounts.

FAQs

Do I need an EIN for a sole proprietorship?

You will need an EIN if you want to hire employees or pay excise, alcohol, tobacco, and firearm taxes. The IRS maintains a checklist for EIN requirements.

How do I change my business type?

You can use Swyft Filings’ conversion services to get started and choose your next business structure or even dissolve the business entirely.

What are the benefits of converting from an LLC to a sole proprietorship?

If your business has a low cash flow, you may be paying more to maintain your LLC’s good standing (annual reports, state tax for filing, franchise tax) than you get from tax deductions on business expenses.

What is the difference between an LLC and sole proprietorship?

An LLC is a separate legal entity from you, protecting your personal assets from being claimed in court. A sole proprietorship is the default informal business structure for individuals who provide services independently.

What are the benefits of a sole proprietorship?

Sole proprietorships require minimal documentation to set up and provide services. In most cases, you don’t have to register with the state or get any licenses to start working.

Bibliography

1. Chamber of Commerce. “Small Business Statistics." Accessed January 16, 2024.

2. Internal Revenue Service. “Closing a Business.” Accessed January 16, 2024.