There’s a lot of talk on the internet in the entrepreneurial and real estate investing blogosphere regarding the single-member LLC. Some people seem to think they are completely worthless, while others prescribe them like aspirin for headache. However, as is almost always the case, neither extreme is correct. Single-member LLC’s have their place in the spectrum of business entity choices, and whether such an entity is right for you will depend on the details of your own personal situation.
As the name implies, a single-member LLC is simply a limited liability company with one owner (member), instead of multiple owners.
Single-Member LLC Pros
1) Asset Protection: as is the case with any LLC, the single-member LLC will act as a shield to protect your personal assets from the liabilities associated with the business conducted by the LLC. For example: if your LLC owns a rental property, and someone slips and falls on that property and wants to sue the property owner, that plaintiff will be required to sue the LLC, not you personally. If the plaintiff ultimately wins the lawsuit, he or she will only be able to come after the assets owned by the LLC, not the LLC owner. The same protection applies to protect the owner from any debts of the LLC.
2) Disregarded Entity Tax Status: a single-member LLC will be treated as a “disregarded entity” for federal income tax purposes (unless it formally elects to be treated as a corporation), and thus its profit or loss will be reported on an individual member’s 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 need not file any tax return.
3) Ease of Use: there are very few legal requirements when it comes to running an LLC. The state will not require you to file annual reports or annual minutes. You really don’t have to keep any minutes at all. However, beware of this potential trap! See the list of “cons” below to see how to avoid this problem.
Single-Member LLC Cons
1) Don’t Fall Asleep at the Wheel: Since little is required, most people do almost nothing in regard to keeping records of actions taken by the LLC. In many cases, they don’t even have an Operating Agreement, which is the bylaw of the LLC and dictates how the company will function. In such situations, the plaintiff in a lawsuit against the LLC will ask the judge to set aside the asset protection associated with the company by claiming the company is a sham since it has no records and no Operating Agreement. In many cases, the court will agree and the single member [that’s you] becomes personally liable for the business debts. This potential disaster can be avoided through good corporate governance and annual maintenance.
2) Lack of “Outside” Liability Protection: unlike multiple-member LLC’s, in most states a single-member LLC will not protect against personal liability in the event of a lawsuit or other claim. Indeed, certain courts have “pierced the veil” of a single-member LLC and have held that it is not a separate entity and thus may not be used to protect the assets of the LLC from the creditors of the member. In order to avoid this issue, we advise clients to do two things: (i) create sufficient legal documentation (including a single-member operating agreement and annual company minutes, etc.) to reflect that the single-member LLC is indeed a separate entity and has been treated as such; and (ii) if there is significant liability exposure, issue a small equity interest (e.g., 2%) to a close relative – i.e., create a multiple-member LLC — in which case, the LLC will no longer be a “disregarded entity” for tax purposes.
While effective in several situations, a single-member LLC is not a silver bullet that will cure all potential asset protection and tax planning problems. It’s important to sit down with a competent legal and tax help to create a solution that is right for you and your goals.