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
- 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. 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.
- 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.
- 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
- 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.
- Lack of “Outside” Liability Protection: Courts in a variety of states have “pierced the veil” of a single-member LLC from the outside 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. EXAMPLE: You get into a car accident texting and you get sued in excess of your insurance policy. Can the plaintiff come after your rental property in an LLC? Answer: The law says in 18 states that IF your LLC is owned by 2 members, they can’t break into the LLC (see Appendix C in my new book “The Tax and Legal Playbook”). However, only THREE states give the Single-Member LLC the same protection as a Multi-Member LLC (Wyoming, Nevada and Delaware). Thus, the Single-Member LLC in the far majority of states will not protect against personal liability in the event of a lawsuit or other claim. In order to avoid this issue, you can do one of two things: (i) create at least a two-member LLC with sufficient legal documentation (including an operating agreement and annual company minutes, etc.) to reflect that the two-member LLC is indeed a separate entity and has been treated as such; or (ii) set up a holding or parent company in Wyoming, Nevada or Delaware to own your other LLCs and force a plaintiff to fight their way through another state before getting to your ‘other’ Single-Member LLCs owned by your ‘Parent’.
Where do they work best?
- For those with a brand new rental property: A Single-Member LLC is a great place to start if you just bought your first rental property, or really only have a few rentals. As the number of your rental properties grow, and maybe even located in several states, setting up a Multi-Member LLC or Multi-Entity Structure (see below) is something you can easily expand into. Remember, the benefit of an LLC is their flexibility and the ability to expand and grow your asset protection structure as your wealth increases.
- Multi-Entity Structuring: If your properties are NOT in a Series LLC state, you may want to set up a Multi-Member ‘Parent’ or ‘Holding LLC’ that owns your other Single Member LLCs in the same state or other states. This allows for a consolidated tax return (saving on tax prep fees), but gives you the inside AND outside protection with multiple buckets all flowing back into one entity.
- The Operational Business Start-up and Convert to S-Corporation Later: I really like the idea of starting your ‘operational’ business as a Single-Member LLC and graduating to an S-Corp (with a simple S-Election) when your income reaches a certain level. EXAMPLE: Rather than wait to set-up an S-corp when it could be too late and cost you Self-Employment tax, start as a Single-Member LLC and then you can make a retroactive S-Election to the LLC after you see the net-income and implement the salary/dividend split of the S-Corp without paying any Self-Employment tax. If you don’t make the income, at least you have the asset protection of the Single-Member LLC and could even start building corporate credit under the EIN of the LLC.
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. Their are lots of options and the Single-Member LLC could provide just the right weapon in your arsenal. 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.
Mark J. Kohler is a CPA, Attorney, Radio Show host and author of the new book “The Tax and Legal Playbook- Game Changing Solutions For Your Small Business Questions” and “What Your CPA Isn’t Telling You- Life Changing Tax Strategies”. He is also a partner at the law firm Kyler Kohler Ostermiller & Sorensen, LLP and the accounting firm K&E CPAs, LLP. For more information visit him at www.markjkohler.com.