The LLC is touted as a great business entity for small businesses. This is particularly true for single member LLCs. If you are considering forming one of these entities, it is important to realize there are pros and cons that need to be taken into account.
What is a single member LLC? A person that has an ownership interest in an LLC is called a “member” instead of a “shareholder” is as the case with corporations. As a result, a single member LLC is a limited liability company that is owned by one person instead of multiple parties. This may sound insignificant, but it actually is very important. Let’s look at the pros and cons of this business entity choice.
The single member LLC is touted primarily because it provides the owner with asset protection, but is relatively simple to run. So, what do we mean by asset protection? Well, the LLC is treated as a separate “person” for legal purposes. Any debts it incurs by contract, lawsuit or whatever are its alone, not the owner. As a result, the owner is “shielded” from the debts of the entity, which is a form of asset protection.
A second positive aspect of the LLC is the ease of use. By this, I mean there are very few legal requirements when it comes to running an LLC. You don’t have to have annual minutes. You really don’t have to keep any minutes at all. This obviously makes things pretty simple, but this is also a trap as we will see in the cons section of this article.
There is a sneaky con from a tax perspective when it comes to an LLC. Most of these entities are marketed with the statement that they can pay taxes like a partnership. This is true if there are two or more members. Since we only have one member, the IRS will reject partnership tax return filings. Instead, the agency will require you to file as though the entity is a sole proprietorship. This means you end up paying self employment taxes. At a rate over 15 percent, this can be a nasty surprise.
The second con is found in the simplicity of running an LLC. 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. That is a disaster.
A single member LLC definitely has a place in the world of business entities. If you decide to go with one, make absolutely sure you understand the tax ramification and have a solution for the internal corporate documents you need including an Operating Agreement and minutes.