Why Become a Single-Member Limited Liability Company?
Much is said about Single-Member Limited Liability Companies (“LLC”). Some in the legal community believe they provide no real benefit, while others think they are the best possible business solution. The truth is it all depends on what you plan on using the LLC for.
So what is a Single-Member LLC? Well as the name implies it’s a limited liability company, which is owned by a single individual as opposed to multiple owners. The following are the positives and negatives of Single-Member LLCs:
Personal Liability Protection:All LLCs, including Single-Member LLCs, afford their owners a shield of liability that protects their personal assets from liabilities that arise from the actions of the business. For example, say you are a landlord who owns a rental property where a tenant slips and falls because of your failure to maintain a public area, such as a sidewalk. If you personally own that rental property, you are personally liable for any damages. Conversely, if the property is owned by an LLC, and not an individual, the individual’s personal assets are protected from any claim the tenant may make. The same protection applies to protect the owner from any debts of the LLC.
Tax Status: A Single-Member LLC generally is treated as a “disregarded entity” for federal income tax purposes and will report its profits and losses on its 1040 Schedule C as if it were a sole proprietorship. This will save the member time and money in connection with the preparation of income tax returns, since the separate LLC entity does not have to file a separate corporate tax return.
Lack of Corporate Formalities: Unlike a corporation, there are no corporate formalities associated with running and operating an LLC. This means that while you may have to pay an annual fee to the state where the LLC resides, you are not required to send out notices, conduct annual meetings, or maintain meeting minutes.
Credibility & Reputation: Forming an LLC will create a sense of credibility with those whom you conduct business. The ability for a business or customer to verify your existence with your state opens doors and opportunities not allowed to sole proprietorships or partnerships.
Potential Limits to Protection: Single-Member LLCs in certain states are not advisable to protect the member’s personal assets, as many jurisdictions take the position that a charging order, or the order which protects personal assets against business liabilities in a given state, is intended to protect the other “innocent” owners and thus the LLC structure may be ignored if a Single-Member. This may also apply to married couples whom jointly own an LLC even though it technically is not a Single-Member since they will share any liability as spouses which may come towards the LLC.
For Example, while driving to work you run a red light and hit a pedestrian. The pedestrian sues and obtains a judgment in excess of your auto policy insurance. Approximately 20 states will allow the pedestrian to pierce a Single-Member, LLC to come after your business properties, including rentals.
A few states, however, treat Single-Member and Multiple-Member LLC’s the same. These states include Alaska, Delaware, Nevada, and Wyoming. There are a few possible remedies to avoid this issue:
Create at least a Multi-Member LLC; or
Form a holding or parent company in Alaska, Delaware, Nevada, or Wyoming, to own your other entities forcing creditors to litigate their way through another jurisdiction before letting them attach your business assets.
Maintaining Proper Operating Agreements: While, as mentioned above, most states do not require LLCs to follow corporate formalities, this does not eliminate the need for an LLC to maintain a proper Operating Agreement which outlines how the company will function. Most states maintain Limited Liability Company Acts, which operate as a default provision should an LLC not have an Operating Agreement. A lot of times, however, these “LLC Acts” are too general and fail to meet the specific needs of your business. For that reason its better to have and maintain an Operating Agreement carefully crafted to address your specific needs.
Rental Properties: A Single-Member LLC is a great vehicle for landlords and owners of rental properties. Approximately 24 states require an LLC to be registered in the state where the property is located. For investors who have properties in multiple states it is advisable to create a parent LLC in one of the aforementioned states to own the local LLC, in the given state. This gives you flexibility and protection. In another blog I will discuss the benefits and detriments of using a Series, LLC.
Operational Businesses: In a lot of cases, your business at the beginning and its current earnings are not sufficient enough to justify creating a corporation. One of the other benefits of an LLC is that it can be taxed as a sole proprietor, partnership, S-Corporation, or C-Corporation. In this way, you could form an LLC and then at a later point make an election to be taxed as a S-Corporation.
In this way, you can make a later S-Corporation election retroactive once you start achieving sufficient income from the entity without having to pay self-employment taxes. As such, even if you don’t immediate see any income from the entity you can enjoy the asset protection, credibility and reputation under the LLC.