More and more individual entrepreneurs are choosing the LLC over the sole proprietorship when starting their business, and with good reason. LLCs provide a number of benefits over the sole proprietorship such as asset protection and the potential for tax savings.
Advantages of a Single-Member LLC
- The primary advantage of a Single Member LLC (SMLLC) over a sole proprietorship is the liability protection it provides. The LLC is a separate legal entity from the individual which means the owner’s personal assets are protected in most cases should the business face legal action. As a sole proprietor, the business and individual are legally considered the same. This means the individual is liable for the activities, debts, and obligations of the business. It is important to note that even though the members of an LLC have liability protection, if they sign a personal guarantee for a business loan, which lenders will almost always require, the members will still have to repay the loan if the business is unable to.
- Having a formal entity like the LLC is perceived as a more legitimate business by customers.
- As a part of the process of registering an LLC in the state, there is some protection from others using the name of the business. Each state requires a unique name, however the definition of what is unique varies by state and doesn’t typically stop a non-registered business (sole proprietorship or partnership) from using a similar name.
A trademark is a better way to protect your business name.
How to Form a Single-Member LLC
The formation of an LLC happens at the state level, often with the Secretary of State or other similarly named state agency. The first step is filing the Articles of Organization (called the Articles of Formation or Certificate of Formation in some states). An attorney isn’t required to form an LLC, but it’s beneficial to either do the research or get professional guidance to be sure the filing it is done right and ongoing requirements are being met. See our guides to forming an LLC in each state.
How is a Single-Member LLC taxed?
A SMLLC offers multiple options over how the profits are taxed. By default, a SMLLC is considered by the IRS (Internal Revenue Service) to be a “disregarded entity”. A disregarded entity is an entity that is separate from the owner for liability reasons but is not separate from the owner for taxes. The profits or losses flow directly to the owner where they are reported on the owner’s personal income tax return.
An LLC can also elect to be taxed as a corporation by filing IRS Form 8832: Entity Classification Election. When an LLC elects to be taxed as a corporation, it now completes a corporate business tax return, IRS Form 1120 or IRS Form 1120S. The benefit of being taxed as a corporation over a disregarded entity is that the entity’s net income can be taxed at the corporate level, and any remaining profits can be distributed as dividends and distributions. The benefit is any dividends and distributions are not subject to self-employment taxes.
Just as any other entity, Single-Member LLC’s are also subject to federal and state taxes. These taxes are the same for any business entity.
Are there any issues forming a Single-Member LLC?
A unique protection only provided by the Limited Liability Company is what’s called charging order protection. Charging order protection prevents a creditor from taking the assets of an LLC due to the personal debts, judgements or garnishments of a member. This protection only places a lien on that individual member’s LLC interest where a percentage of the profits go to paying their personal debt. This protects the remaining members from having to dissolve the entity to satisfy the debt or allow the creditor to have a say in the operations of the business. By operating as a Single Member, this protection is lost.
What are the requirements to run a SMLLC?
The requirements to run an LLC are much lower than a corporation, however there are a few things to keep in mind.
- Be sure to keep income and expenses separate from your personal bank accounts. Commingling funds risks penalties from the IRS and/or your state’s Department of Revenue should the business be audited.
- To best maintain the liability protection of the LLC, ensure that all contracts, purchase orders, bids etc. are signed on behalf of the LLC. Otherwise, if a member of an LLC signs their name, they may end up being personally liable. An example of how to sign is “Bob Smith, on behalf of Acme LLC”.
- LLCs are required to file a periodic report, usually called the Annual Report, along with a filing fee. In addition, there may be franchise taxes (taxes for the privilege of doing business in the state). Not reporting on time risks the LLC not staying in good standing with the state. This could result in the forced dissolution of the entity.
Can a Single-Member LLC have employees?
Just as a sole proprietor or partnership can have employees, so can a Single-Member LLC. Be sure to get an EIN and register with the appropriate state agencies before hiring.
There is no cost to get an EIN, and only takes a few minutes to register. Learn how to apply for an EIN.
When does a Single-Member LLC need an EIN?
The EIN or Employer Identification Number is a nine-digit number from the IRS to identify tax accounts for a business. A Single Member LLC that does not elect corporation tax status (stays as the default disregarded entity) and has no employees does not need an EIN. They will instead use their SSN (Social Security Number) or TIN (Taxpayer Identification Number).
Even though the EIN may not be required by state agencies, some banks will want one before opening a business bank account. Learn how to apply for an EIN at no cost.
How does the owner of a Single-Member LLC get paid?
By default, a Single Member LLC is classified as a disregarded entity by the IRS. Unless the LLC elects to be taxed as a corporation, the owner will be considered self-employed. The sole member doesn’t get “paid” a salary but instead takes distributions from the profits of the business.
How does a single-Member LLC pay into Social Security?
As a Single Member LLC, the owner pays self-employment taxes on all profits. Self-employment taxes include both Social Security and Medicare.
Is an LLC owned by both spouses considered a Single-Member LLC or Multi-Member LLC?
In community property states (Alaska, Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin), you can have a Single-Member LLC that is owned by both spouses for tax purposes.
The laws in a community property state indicate that any property acquired by a married individual is also owned in common by a spouse. This includes any profits from an LLC. The IRS allows LLCs in community property states to allow a SMLLC to file as a disregarded entity for tax purposes.
Is a Single-Member LLC required to have an Operating Agreement?
Only six states require LLCs to have an Operating Agreement (California, Delaware, Maine, Missouri and New York). This operating agreement doesn’t have to be filed with the Secretary of State or any other state agency for that matter, but needs to be kept on file.
Even though it isn’t required, an Operating Agreement can be very useful, even for a Single Member LLC. A formal Operating Agreement helps to prove the LLC is separate from its owners which can improve the liability protection and any potential tax breaks should the entity elect corporation taxation.