How to Set up a Sole Proprietorship in Ohio

Created byВ FindLaw’s team of legal writers and editors | Last updated February 16, 2018

In its simplest form, a sole proprietorship is just a one-person business that doesn’t have to be registered with the state, unlike a limited liability company (LLC) or a corporation. It is by-far the easiest business structure to set up and maintain. If you are running your own one-person business, then you may already be operating as a sole proprietorship without even knowing it.

Indeed, there are some situations when people automatically set up a sole proprietorship, even without paperwork. Some examples include freelance photographers, a person who builds cabinets on a contract basis, and even salespeople that work solely on commission. Just because you may have already set up a sole proprietorship, however, does not mean that there’s nothing else you need to do. Below are some suggestions for how to set up a sole proprietorship.

Setting Up a Sole Proprietorship: At a Glance

Some states have laws mandating that sole proprietorships register and get business licenses. In addition, you should also make sure that you have all the required permits that allow you to perform your duties. It’s also important to realize that you should not try to use your business as a tax shelter or some other loophole, as any profits that your business sees will translate to you as income for your personal tax return. By extension, if your business owes any debts, you owe those debts, and creditors can come after your personal assets if your business can’t afford to pay.

No Limited Liability

Unlike a corporation or LLC, owners of sole proprietorships do not enjoy the comforts and security provided by limited liability. Because of this, if there is a judgment or debt owed by your company, the creditor or judgment seeker can come after you and your personal assets just as easily as they can go after the assets of your company. In other words, if you make a blunder on the job as a sole proprietor, it could cost you your bank accounts and/or your home.

To clearly see this point, it is helpful to look at some examples:

Suppose that Manny owns and operates a machine shop in his home garage.

With the construction of a custom car shop in Manny’s hometown, he has recently run into many more orders than he has ever had before. Because of this, he decides to order a new lathe to make custom exhaust pipes for the cars that the car shop builds. He finances the $100,000 piece of equipment through the seller and makes regular payments for two months before the custom car shop closes its doors. As a sole proprietor, Manny is personally liable for the business debts of his company. After the company repossesses the lathe, they still demand $20,000 for the reduction in value because the lathe was used. The lathe company can seek this money from Manny’s personal assets, such as his car or even his home.

Now suppose that Manny has one employee in his shop that not only helps him make the exhaust pipes, but also delivered them to the, now closed, custom car shop. One day while driving over two new exhaust pipes in the company truck, Manny’s employee hits another car, causing damage to the car and injuries to the other car’s driver. The driver sues the employee and Manny’s company, and the court rules that a $200,000 settlement is in order. Manny’s insurance will only cover $150,000 of the claim, leaving Manny personally liable for $50,000, which could be taken from any of his personal assets (with a few exceptions).

As noted above, sole proprietorships do not provide owners with any form of limited liability. If Manny had organized his company as an LLC or a corporation, he could have enjoyed limited personal liability. Both the creditor and the injured driver would only be able to seek money from the assets of the company, not from Manny himself. This is why it makes sense to form you business as an LLC or corporation if you foresee that your business will be engaged in a dangerous activity, or if you have personal assets that you want to protect from potential liability.

Taxes and Sole Proprietorships

Unlike a corporation, which is its own tax entity, a sole proprietorship does not pay taxes as a business. Instead, because the business and the owner of the business are one and the same, the taxes “pass through” the business to the owner. This means that all business profits and losses are reported on the owner’s tax return.

If you do set up a sole proprietorship, you will have to be responsible for paying your taxes by yourself. This means that not only should you self-withhold taxes for the IRS and the state that you live in, but you also must pay taxes for social security and Medicare. You will need to engage in a “self-employment tax.” You should visit the Internal Revenue Service at to find out more about this tax.

Sole Proprietorship Registration

As an owner of a sole proprietorship, you will probably not have to go through the same process of registering as an LLC or a corporation. When you start your new business, you will simply declare that you are running a sole proprietorship instead of filing paperwork with the state creating a corporation.

Almost every city and county in the nation requires that any business, even a sole proprietorship, register and pay at least a small tax, however. In return for this tax and registration, your business will receive a business license and tax registration certificate. In addition to these documents, you should also go about getting a federal employer identification number from the Internal Revenue Service (so you can withhold taxes from your employees), a license to sell from your state, and a zoning permit from your local land planning board if it is required.

Also, if you plan on doing business under a name other than your own legal name, you will probably be required to register that name as a “fictitious business name” with your local county or state government.

Get Legal Help Setting Up Your Sole Proprietorship

Although it’s relatively easy to set up a sole proprietorship without the assistance of an attorney, you may still have some questions about liability, taxes, and other possible risks. You should speak with a business organizations attorney in your area to help answer your additional questions and guide you through the process of setting your business up.

A sole proprietorship is an unincorporated business that is owned by one individual. It is the simplest kind of business structure.

The owner of a sole proprietorship has sole responsibility for making decisions, receives all the profits, claims all losses, and does not have separate legal status from the business. If you are a sole proprietor, you also assume all the risks of the business. The risks extend even to your personal property and assets.

If you are a sole proprietor, you pay personal income tax on the net income generated by your business.

You may choose to register a business name or operate under your own name or both.

If you operate as an individual, just bill your customers or clients in your own name. If you operate under a registered business name, bill your clients and customers in the business’s name. If your business has a name other than your own, you’ll need a separate bank account to process cheques payable to your business.

Payment of taxes on business income

A sole proprietor pays taxes by reporting income (or loss) on a T1 income tax and benefit return.

If you are a sole proprietor, you or your authorized representative have to file a T1 return if you:

• have to pay tax for the year
• disposed of a capital property or had a taxable capital gain in the year
• have to make Canada Pension Plan/Quebec Pension Plan (CPP/QPP) payments on self-employed earnings or pensionable earnings for the year
• want to access employment insurance (EI) special benefits for self-employed persons
• received a demand from us to file a return

The list above does not include every situation where you may have to file. If you are not sure whether you have to file, call 1-800-959-5525 .

As a sole proprietor, you may have to pay your income tax by payments called instalments. You may also need to make instalment payments for CPP contributions on your own income. For more information, go to Paying Your Income Tax by Instalments.

When you file your income tax and benefit return, you must include financial statements or one or more of the following forms, as applicable:

We will also accept a computer-generated version of these forms.

Registration for GST/HST

As a sole proprietor, you may be required to register for the goods and services tax/harmonized sales tax (GST/HST) if you provide taxable supplies in Canada.

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5. Sole Proprietorship

• Most common
• Simplest form of business organization
• Easily formed; easily discontinued
• Least regulated
• Most flexible in response to business requirements

Legally, and for tax purposes, the individual owner is the business. A business that is jointly owned by husband and wife who file a joint tax return is generally operated as a sole proprietorship.

The liabilities and profits of a sole proprietorship are personal to the owner. All of the sole proprietor’s personal and business assets are at risk.

The sole proprietor has total control of the business. When the owner dies, the business ceases to exist with the assets and liabilities passing to the estate.

There are no administrative requirements other than obtaining appropriate licenses and registration of the trade name.

Trade Name

A trade name is a name assumed by the sole proprietor that does not include:

• The surname of the individual proprietor; or
• The first name and surname of the individual proprietor when a license is required to transact business.

According to North Dakota law, NDCC, Section 47-25-01, a sole proprietor may not engage in business using a trade name unless it is registered with the Secretary of State. To obtain a license or permit to operate a business, a sole proprietor must register the trade name with the Secretary of State.

The registration of the trade name:

• Affords exclusive right to that name in the State of North Dakota. No other business may file a name with the Secretary of State that is the same as, or deceptively similar, to any registered name.
• Establishes a public record from which the name of the owner of the business can be identified.

If the ownership of a business name changes during the five-year registration period, the ownership of the trade name is assignable to the new owner. The Trade Name Assignment does not extend the registration period of a trade name, but rather affords ownership to the new owner for the remainder of the registration period.

Franchise Name

A franchise name is a name to which an independent operator has secured the rights from a franchiser or licensor to use and distribute products or services, techniques, and trademarks for a percentage of sales or royalty fees. Franchise agreements often convey additional support services, advertising and training from the franchiser or licensor.

Franchise Name Disclosure: An individual or organization that is a franchisee does not usually gain ownership to the franchise name and could therefore not file a Trade Name Registration. However, a franchisee must file Franchise Name Disclosure information with the Secretary of State before using the franchise name in the State of North Dakota. The Franchise Name Disclosure is made on the same form used for filing a Trade Name Registration The filing of the disclosure information does not extend any trade name protection provided by N.D.C.C., Chapter 47-25.

Forms

Forms to submit filings and update information are now available on FirstStop, the Secretary of State’s new online filing system.

A sole proprietorship is the simplest and most common structure chosen to start a business. It is an unincorporated business owned and run by one individual with no distinction between the business and you, the owner. You are entitled to all profits and are responsible for all your business’s debts, losses and liabilities.

Forming a Sole Proprietorship

You do not have to take any formal action to form a sole proprietorship. As long as you are the only owner, this status automatically comes from your business activities. In fact, you may already own one without knowing it. If you are a freelance writer, for example, you are a sole proprietor.

But like all businesses, you need to obtain the necessary licenses and permits. Regulations vary by industry, state and locality. Use the Licensing & Permits tool to find a listing of federal, state and local permits, licenses and registrations you’ll need to run a business.

If you choose to operate under a name different than your own, you will most likely have to file a fictitious name (also known as an assumed name, trade name, or DBA name, short for “doing business as”). You must choose an original name; it cannot already be claimed by another business.

Sole Proprietor Taxes

Because you and your business are one and the same, the business itself is not taxed separately-the sole proprietorship income is your income. You report income and/or losses and expenses with a Schedule C and the standard Form 1040. The “bottom-line amount” from Schedule C transfers to your personal tax return. It’s your responsibility to withhold and pay all income taxes, including self-employment and estimated taxes. You can find more information about sole proprietorship taxes and other forms at IRS.gov.

Advantages of a Sole Proprietorship

• Easy and inexpensive to form: A sole proprietorship is the simplest and least expensive business structure to establish. Costs are minimal, with legal costs limited to obtaining the necessary licenses or permits.

• Complete control. Because you are the sole owner of the business, you have complete control over all decisions. You aren’t required to consult with anyone else when you need to make decisions or want to make changes.

• Easy tax preparation. Your business is not taxed separately, so it’s easy to fulfill the tax reporting requirements for a sole proprietorship. The tax rates are also the lowest of the business structures.

Disadvantages of a Proprietorship

• Unlimited personal liability. Because there is no legal separation between you and your business, you can be held personally liable for the debts and obligations of the business. This risk extends to any liabilities incurred as a result of employee actions.

• Hard to raise money. Sole proprietors often face challenges when trying to raise money. You cannot sell stock in the business, which limits investor opportunity. Banks are also hesitant to lend to a sole proprietorship because of a perceived additional risk when it comes to repayment if the business fails.

• Heavy burden. The flipside of complete control is the burden and pressure it can impose. You alone are ultimately responsible for the successes and failures of your business.

There are many ways to set up your massage business structure. The best information will come from your accountant and business advisers. The Small Business Administration (SBA) has a lot of information to assist you in setting up your massage business structure.

The most common for massage businesses are being a sole proprietor or forming an LLC (Limited Liability Company). If you don’t set up a LLC or Corporation you will automatically be considered to be a sole proprietorship.

In a sole proprietorship you own the business. You can also be a sole proprietorship when you are an independent contractor for another business. You are responsible for the profits and losses as well as the success or failure of the business. You can choose a business name or just have it be under your own name. In general, you will just keep track of income and expenses and have a separate business bank account. When you file taxes you will use a Schedule C – Profit and Loss from Business. With this type of business you are personally liable if anyone gets hurt or makes a claim against your business. That will include your home and personal assets too. If you want to get loans from banks it will depend on your personal credit as compared to the value of a business. You will need a business license in your city or county. You will also have to pay Self employment tax. You usually will make quarterly tax payments.

LLC’s provide some liability protection. You don’t pay income tax but it will help protect your personal assets. You will have to file the appropriate articles and paperwork with your secretary of state and set up an operating agreement outlining the details of the business. There will be variations in each state.

A Sole proprietorship is easier to set up and deal with but doesn’t offer any personal protection. The thing though for massage therapists is that it is easy to get caught up in the business and start thinking that you and you alone are the business. You start working in the business instead of on the business and it is hard to separate you from the actual business. In that way it can bring up more challenges on the path to success. While many do just start a sole proprietorship because of the ease of setting it up, doing it with awareness can help you to separate yourself from the business.

Some of the things that you can do right from the start is to begin with the goal of selling your business in the end or at some time. The policies and procedures that you set up for your massage business will also help to keep you separate from the business enough to help keep it successful yet fulfilling.

Be sure to contact an attorney to help you set up the appropriate massage business structure. In WA State, massage practitioners will need to be a PLLC and can’t be a LLC. (according to AMTA WA attorney John Peick)

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Report and pay FUTA tax if your company either:

If you are an employer, you must file a quarterly Form 941 to report:

• Wages you have paid,
• Tips your employees have received,
• Federal income tax you withheld,
• Both employer’s and employee’s share of social security and Medicare taxes, and

After you file your first Form 941, you must file a return each quarter even if you have no taxes to report, unless you are filing a final return or meet one of the exceptions.

This form was designed so the smallest employers (those whose annual liability for Social Security, Medicare, and withheld federal income taxes is $1,000 or less) will file and pay these taxes only once a year instead of every quarter.

The IRS will notify those employers who will qualify to file Form 944 in February of each year.

Important: Every corporation must file Forms 1099-MISC if, in the course of its trade or business, it makes payments of rents, commissions, or other fixed or determinable income (see section 6041) totaling $600 or more to any one person during the calendar year.

Also use these returns to report amounts received as a nominee for another person. For more details, see the General Instructions for Forms 1099, 1098, 5498, and W-2G.

Report the following:

Use Form 8829 to figure the allowable expenses for business use of your home on Schedule C (Form1040 or 1040-SR) and any carryover to amounts not deductible in the prior year.

If all of the expenses for business use of your home are properly allocable in inventory costs, do not complete Form 8829. These expenses are figured in Schedule C, Part III.

Note: If you are claiming expenses for business use of your home as an employee or a partner, or you are claiming these expenses on Schedule F (Form 1040) do not use form 8829. Instead, complete the worksheet in Publication 587, Business Use of Your Home.

Advantages and Disadvantages of Sole Proprietorship

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Most small businesses are sole proprietorships because this type of business is the easiest and least expensive way to start a business. In fact, the IRS reports that for 2016 (the last year calculated) over 25.5 million businesses paid taxes as sole proprietors, by filing Schedule C of Form 1040.  

What is a Sole Proprietorship?

The sole proprietorship is the oldest and simplest form of business ownership. A sole proprietorship (or “sole prop”) is a form of business in which an individual starts a business under his or her own name. It’s a one-person business; if there is more than one owner, your business can’t be a sole proprietorship. In a sole proprietorship, you are the business; that is, the business is not a separate entity from you.

The IRS calls a sole proprietor someone who owns an “unincorporated business by himself or herself).” That means the business isn’t a corporation (or S corporation) or a single-owner limited liability company (LLC).  

Many sole proprietors work from home. This article on Starting a Home Based Business answers commonly asked questions about the additional requirements for starting your sole proprietorship from home.

How Does a Sole Proprietorship Get Started?

A sole proprietorship is unique because it’s the only business that doesn’t have to register with a state. All other business types – partnerships, limited liability companies, and corporations – must file a registration form with each state in which they do business.  

Starting a sole prop business is fairly simple. To start a sole proprietorship, all you need to do is:

• Create a business name and decide on a location for your business
• File for a business license with your city or county, and get permission from your locality if you want to operate your business from home.
• Set up a business checking account so you don’t mix up business and personal spending.

In addition, your sole proprietorship may need to register with federal or state entities (these registrations are the same for all types of businesses):

• if you plan to sell taxable products or services, you’ll need to register with your state’s taxing authority.
• if you plan to hire employees, you’ll need to get an Employer Tax ID Number (EIN) from the IRS. (Your bank may also require this tax number.)

Advantages of Sole Proprietor Form

The advantages of forming a sole proprietorship include:

Easy Startup. You don’t need to prepare any legal agreements because you are not in business with someone else, and you don’t have to set up an elaborate business structure: no board of directors, no meetings, no minutes, no complicated accounting for shares in the business. You just start running your business.  

Control. As the sole owner of the business, you have complete control over all the operations, and you get to make all the decisions. You don’t need to have a board of directors, shareholders, or other owners to answer to.  

Tax Preparation and Filing. Sole proprietorship income taxes are easy to file, using Schedule C and adding the income/loss from the business to your other income on your personal tax return.

Use of Losses. Because you are including your sole proprietorship income/loss on your personal tax return, you can use any business losses to offset personal income from other sources (a spouse’s salary, for example).

To take the maximum loss, you must actively participate in the business and not be just an investor.   You also need to be careful not to run up against the IRS restrictions on “hobby” businesses which generate losses for years. If you can prove your business is legitimate and not a hobby, those losses can lower your taxes.  

To learn more about limits to business losses, see this article about Claiming Business Losses on your Tax Return.

Disadvantages of the Sole Proprietorship

The primary disadvantage of a sole proprietorship is that your personal finances and those of your business are one and the same. You as the owner are personally liable for any debts or obligations of the business. Lawsuits or creditors may be able to access your personal accounts, assets, or property if your business can’t pay its bills.  

You cannot file bankruptcy for your business without filing personal bankruptcy. Filing bankruptcy your sole proprietorship means involving your personal assets. A bankruptcy case involving a sole proprietorship includes both the business and personal assets of the owners and debtors.  

For many business people, the issues of personal liability and involvement of personal assets outweigh the advantages of sole proprietorship structure. If this is the case with you, consider forming a limited liability company (LLC) or corporation.

Getting Business Insurance Protection

You can’t protect your personal assets if your business is in trouble financially, but you can get some protection from liability lawsuits if you get property and liability insurance. You will probably have to get this insurance specifically for your business, but it can help protect you if your business is involved in a liability lawsuit.

If you drive your car for business, you might want to get business auto insurance to cover you while on business trips. Most personal auto policies won’t cover business driving.

Taxes and Sole Proprietorships

The sole proprietor pays federal and state income taxes on all of the net income of the business (income minus deductions), even if you don’t have cash in hand to pay these taxes.

Your business income is included with your personal income on your personal tax return. The tax rate you pay may on the business income is hard to determine, since it’s all combined. The corporate tax rate is a flat 21% for all corporate income levels, so your tax rate may be higher or lower, depending on your personal tax rate.

Don’t forget sef-employment tax. Sole proprietors must pay self-employment tax on the profits of their business, for Social Security and Medicare. Since this tax isn’t withheld from your business income, you’ll probably need to make quarterly estimated tax payments for this tax and your business income tax.

The IRS publishes a Tax Guide for Small Business, which you might find helpful in dealing with federal taxes.

Check with Tax and Legal Professionals

Even if you have a very small one-person business, you should check with your tax and legal advisors before settling on a business form. There may be other things you need to consider before you start a sole proprietorship business.

A sole proprietorship automatically exists whenever you engage in business by and for yourself, without partners and without the protection of an LLC, corporation, or limited partnership. Although it sounds fancy and complicated, forming a sole proprietorship is about as easy as it gets.

Forming a sole proprietorship

When you begin transacting business, be it selling crafts at the local art fair or doing web design work in your spare time, you become a sole proprietor. Your state, city, and/or county may impose some business license requirements and fees on you in order for you to be allowed to do business in your current location, but aside from those few formalities, you’re in business.

To do business under a name other than your own, you can file a fictitious firm name statement (also called a DBA) with your county clerk. A DBA enables you to market your services under the name “Super-Duper Fantastic Web Design” rather than simply “John Smith.”

There are a few drawbacks to sole proprietorships. Namely, even if you file a DBA, you’re still a sole proprietorship. So, although you may be operating under a name other than your own, don’t get any lofty ideas that your business is anything other than just you. A DBA offers no barrier of legal separation between your business and yourself, and that fact should scare you.

Shouldering full liability: The buck stops with you

Even though a sole proprietorship is simple to set up, it has many disadvantages. When you operate as a sole proprietorship, your personal assets are unconditionally at risk from being seized by an angry creditor or a lawsuit gone bad.

There is an old saying, “You aren’t in business until you’ve been sued,” and as a sole proprietorship, you’re handing over all your hard-earned assets (your home, your car, everything) on a silver platter.

Sole proprietorships are popular because they are super cheap and easy to form. You start selling a product or service and generate your first dollar of revenue and boom — you’re a sole proprietorship.

However, if the business you’re pondering involves any interaction with the public, the costs you could find yourself facing can quickly eclipse whatever start-up fees you were trying to avoid in the first place. You won’t think that they’re so cheap and easy if you lose everything you own.

Exploring some more disadvantages

Here are a few other drawbacks to ponder:

Limited financing options. Unlike LLCs, which have membership interests, sole proprietorships don’t have interests or any other form of ownership in the company. Your business is you, and you can’t sell little pieces of yourself. This setup creates quite the conundrum if you want to raise money for your new venture by selling ownership interests.

No separate credit. As an unincorporated entity, you cannot obtain credit in the name of the business. You’re stuck using your own personal credit for things such as business loans and leases.

Limited life span. With no legal separation between you and your business, your business is subject to the same limitations that you are: namely, your lack of immortality. In other words, your business dies when you do. After you pass away, instead of carrying on in one piece, your business goes through probate, and your business assets are ripped apart and possibly even liquidated.

All these disadvantages don’t change the fact that sole proprietorships are easy. You don’t have to do anything to form one, and you don’t have to worry about recordkeeping requirements, keeping separate accounts, or accidently commingling funds like you would with a limited liability company or corporation.

In a sole proprietorship, you get the benefit of being autonomous. You are the business; therefore, you answer to nobody.

At the end of the day, you need to decide whether going through the trouble and expense of forming your business as an LLC is worth your while.

When you go into business, you need to be under the protection of an LLC or a corporation; however, before undertaking the formation process, operating as a sole proprietor for a bit to test your market is okay.

Losing LLC benefits with disregarded entity taxation

Like the courts, the IRS doesn’t consider a sole proprietorship to be separate from its owner, which is why the IRS treats it as a disregarded entity. Disregarded entities have a form of taxation often referred to as pass-through taxation, because the business isn’t taxed directly. Instead, the revenues and expenses of the business pass through and are taxed directly to the owner.

To calculate business profits and losses, you add a Schedule C to your 1040. On one side of the Schedule C, you list your business revenue; on the other side, you list your business expenses. Subtract one from the other and — voilà! — you get your net profit or net loss. You transfer this number to your 1040 and incorporate the income (or loss) into your normal tax burden.

Before applying your normal income tax rate to your business profits, you need to factor in a 15.3 percent self-employment tax. This tax serves as a substitute for Social Security and Medicare taxes that would normally be taken out of your paycheck. Shocked by the amount?

Well, you may not realize it, but when you pay the 6.2 percent Social Security tax and the 1.45 percent Medicare tax out of your salary each week, your employer has to match it. Now that you are working for yourself, you get the full burden: 12.4 percent Social Security plus 2.9 percent Medicare equals a whopping 15.3 percent!

Make more than most? At higher income levels, you pay an additional 0.9 percent Medicare tax! Luckily, to ease the burden a bit, the IRS allows you to deduct half the total amount of the self-employment tax.

LLCs offer more protection, tax benefits, and other advantages that make them worth considering as business entities.

by Rebecca DeSimone, Esq.
updated September 04, 2020 · 2 min read

Many people who have a sole proprietorship decide that they wish to change or to convert to LLC.

When converting to LLC or opting for an LLC to run your business, remember that, as a sole proprietorship, you and your business are one entity.

You own the business assets personally, the EIN for your business is you, your registration is you – you are your business.

Benefits of an LLC

A limited liability company (LLC) forms a new legal person. That person is now separate and apart from you.

The legal entity has many of the same rights a person does. It can own property, it can own savings and checking accounts, it can buy and sell property, and it can own and operate a fully functioning business.

You and your company are close, but you are two different entities. Since the LLC is a separate person, the LLC absorbs any liability issues.

Here’s a quick comparison of a sole proprietorship vs. LLC:

• As a sole proprietorship, you are personally open to potentially devastating law suits and legal actions. An LLC, however, is separate from you. It will be subject to most lawsuits and other legal obligations and penalties, not you.
• An LLC offers tax advantages over a sole proprietorship, allowing you to structure your business taxes in different ways.
• Since your LLC is a separate legal entity, a new tax ID number and other paperwork is required. This different from you previously having an EIN as a sole proprietorship, your new LLC must register its very own EIN.
• More than one person can be an owner, called a member, of an LLC, as where a sole proprietorship only allows a single owner – you. However, a single-member LLC can be used if you’re the only owner. All this means is that you’ll be the only owner, the rest of the rules for an LLC stay in place.

Can You Change a Sole Proprietorship to an LLC?

You can. Every state allows you to form an LLC when you convert your sole proprietorship to an LLC.

To do so, you will have to contact your Secretary of State for the correct forms. there are few things to keep in mind when you convert a sole proprietorship to an LLC:

• You have to maintain the ‘corporate veil.’ This means you have to make sure your personal property remains separate from the LLC’s property. Most importantly, you need to keep your bank accounts, credit cards, and loans separate. Don’t treat the LLC bank account as a personal checking account.
• You are still responsible for your personal actions and for taxes. The protections offered by an LLC won’t help you dodge the business’ tax burdens, avoid paying loans you’ve personally guaranteed, or protect you if you commit a crime, for example.
• There are time limits for proper transfer, specific filing requirements, LLC taxes, and state regulations to meet – all needed to ensure that your LLC is wholly compliant with your state requirements and regulations.

Once you have put those protections into place, your LLC is ready to keep your business – and you – safe.

It’s better to have an individual 401(k) than a SEP IRA

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There are very few slam dunks in retirement planning, but choosing an individual 401(k)—also known as a one-participant 401(k) or solo 401(k)—over a SEP IRA can be one of them. If you are a sole proprietor and want to maximize your retirement contributions with the lowest cost and the most flexibility, check out these five reasons why an individual 401(k) might be right for you.

Key Takeaways

• You can contribute more to an individual 401(k) than to a SEP IRA.
• Individual 401(k)s allow for loans, while SEP IRAs do not.
• Having an individual 401(k) instead of a SEP IRA can make Roth IRA conversions less expensive.

1. Maximum Pretax Contributions

A key advantage of the individual 401(k) is that the maximum amount you can contribute is higher at every level of net earnings than it is for a SEP IRA.   The chart below shows the maximum contributions you could make at varying income levels and illustrates that the difference between the two can be considerable.

For example, at $50,000 of net earnings, you could contribute as much as $34,294 to an individual 401(k), while the SEP IRA maxes out at only $9,294 (as of 2019). That is a $25,000 difference in favor of the individual 401(k).

The table below shows that individual 401(k) maximum contributions continue to exceed those of the SEP IRA by $25,000 until net earnings reach $200,000. At that point, the difference decreases, but it’s still in favor of the individual 401(k). These maximums assume that you’re eligible for the catch-up provision for anyone age 50 and older, which allows you to contribute an additional $6,500 to a 401(k) in 2020; the SEP IRA has no catch-up provision.    

The individual 401(k) beats the SEP IRA for the maximum plan contribution no matter what your net earnings.   For sole proprietors living in states with high income-tax and for those with additional outside sources of income, this difference could mean the difference between a refund and a bill when it comes time to do your taxes. Because this difference will occur each year, it can put hundreds of thousands of extra dollars in your retirement plan over the course of your career.

2. Contributions Are Discretionary; Loans Are Allowed

Individual 401(k) contributions are not mandatory every year.   This allows sole proprietors to manage their cash flows and contribute the maximum amount in good years while contributing less or nothing at all if their business takes a turn for the worse. In addition, owners can take loans for as much as $50,000 or 50% of the value of the benefits in the plan (whichever amount is lower).  

Although the SEP IRA doesn’t require mandatory contributions, it has no such loan provisions.     The ability to take a tax-free loan from your individual 401(k) in the case of an emergency should be taken seriously because sole proprietors often have variable incomes from year to year.

3. Ease, Low Cost, and Flexibility

Individual 401(k) accounts are easy to open and manage. If you open one at a discount broker, you may incur practically no costs other than for trading. They are also extremely flexible when it comes to investing. In addition, you are not required to file Form 5500 with the Internal Revenue Service, provided your plan contains less than $250,000 worth of assets. This is true for both individual 401(k) plans and SEP IRA plans.  

4. Less-Expensive Roth Conversions

Another notable advantage of the individual 401(k) is that unlike the SEP IRA, it is not considered in determining the pro-rata cost for a Roth conversion.

Suppose that you have a SEP IRA with $100,000 and a traditional IRA with $75,000 ($30,000 of which represents nondeductible contributions). If you convert your total traditional IRA worth $75,000, you would only be able to exclude roughly 17% ($30,000 / $175,000) of the conversion from your ordinary income. This is because the IRS requires you to prorate the nondeductible contributions across your entire IRA balances, including the SEP IRA.  

Now, let’s say that instead of having the SEP IRA, you have an individual 401(k) with $100,000, plus the traditional IRA with $75,000. Again, $30,000 of that amount represents nondeductible contributions. If you convert your total traditional IRA worth $75,000, you would be able to exclude 40% ($30,000 / $75,000) of the conversion from ordinary income as the individual 401(k) is not included in the pro-rata calculation. In both situations, you are converting $75,000 to a Roth IRA, but with the individual 401(k), you pay less in taxes today because you are only recognizing $45,000 ($75,000 x (1-0.40)) compared to the example with the SEP IRA, in which you would have recognized $62,250 ($75,000 x (1-0.17)) in taxable income.  

You could even take this a step further and move all of the pretax money from the traditional IRA to the individual 401(k). Then you would have $145,000 in the individual 401(k) and $30,000 in your traditional IRA, of which 100% would represent nondeductible contributions. In this case, it is possible to then convert the $30,000 traditional IRA and exclude 100% of the conversion from ordinary income, making it an essentially tax-free Roth conversion.  

If you will be in a higher tax bracket when you retire, consider funding an individual Roth 401(k).

5. The Option to Elect Roth Contributions

If you are in a low tax bracket today and would prefer to pay the taxes now, you can elect to have the employee salary deferral portion of your 401(k) contributed after-tax into a Roth individual 401(k). The employer must still contribute before-tax as with a traditional Individual 401(k). The SEP IRA does not have this option.  

Conclusion

In many cases, the individual 401(k) is a better alternative to the SEP IRA for sole proprietors. If you are accustomed to making annual contributions to a SEP IRA, note that the deadline to open an individual 401(k) is December 31, as opposed to the SEP IRA, which you have until April 15 of the following year to fund.    

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