What is a single-member LLC and who benefits?
A single-member LLC begins as a corporation, complete with filed articles of incorporation, and first becomes an LLC. Because there is only one owner, it is then designated as a single-member LLC. For the single owner who wants to have full control, save money and retain more protection than provided by a sole proprietorship, this hybrid between corporation and partnership could be the answer.
The single-member LLC is the perfect structure for rental property ownership. For other business owners, however, this structure which is often considered less costly, easier to manage and a simple choice for small, at-home new businesses, could unexpectedly become their worst nightmare, a tax bracket terror.
Single-member LLC liability issues
Retaining your individuality and choosing simplicity in paperwork comes with some changes in personal liability protection. A multi-member LLC offers what is called ‘charging order protection’ which stipulates that personal creditors cannot seize the partners’ LLC interests, but can only obtain a charging order and receive the percentage of the profits allocated to them. This second level of liability protection prevents the owner (or partners’) personal creditors from seizing the business or its assets to settle personal debts. Since you have chosen to operate without a partner (as a single-member LLC), you have lost this protection.
Once the owner chooses to become a single-member LLC, the IRS considers the business as a “disregarded entity” since the owner disregarded or opted out of the partner requirement. By using the IRS’s “disregarded entity” status, the owner is required to file business taxes on a Schedule C attachment to their individual tax returns. The business becomes very much like a sole proprietorship.
Choices and levels of personal liability protection
Do nothing and you have no protection. You file your business taxes on a Schedule C to your individual taxes. If there are business liability problems, expect them to become your personal, individual liability issues. Expect your spouse to be equally vulnerable. Any liability that may be offered is that the business can’t be held accountable for the owner’s personal obligations. As a disregarded entity (along with the fact that many owners mingle their personal and business books) a single-member LLC is more likely to be overturned in court and personal liabilities of the owner (and spouse) could become a business liability.
Choose a partner and become a multi-member LLC. Right, I know that’s not what you wanted. One of the benefits of selecting the LLC entity is versatility. Choose a partner within a 2% ownership range, preferably not your spouse, since the IRS has too many ways to invalidate that choice. Set up your LLC to be manager-managed, which makes your partner silent with very limited day-to-day exposure, and you keep all the decision-making power. You (and your partner) retain personal liability protection. This route to liability protection could be a very costly tax structure for any operating business except that of rental property.
Become an incorporated entity in the eyes of the IRS and the courts. After filing your LLC, fill out the IRS Form 8832, Entity Classification Election, and choose (elect) corporate tax treatment. Without this election, your single-member LLC is taxed as a sole proprietorship, and every dollar of profit is taxable for federal, state, and self-employment tax. That could become 40% or more on tax.
The single-member LLC becomes the perfect business structure
Once you’ve decided your true style is solo, the simplicity and control offered through a single-member LLC may make it the perfect business structure for you. The catch 22 to this structure is that the advantages can become the downfall of success and the IRS is fully prepared to step in for their piece of the action.
Although the decision to run your business as a single-member LLC provides a level of liability protection, it is a very costly tax structure for any operating business except that of rental property.
The obvious and the less well-known benefits of a single-member LLC allow the business owner to use the tax advantages of the platform to shift expenses which might not otherwise be tax deductible without the Schedule C. Often, the single-member LLC provides as much for lifestyle as it does for business control and simplicity.
Some IRS laws help your Schedule C: The IRS established rules to make your bookkeeping and tax records easier. Many single-member LLC business owners use an extra room as a home office and write off expenses for their personal vehicle, cell phone, and internet services, among other things. Even the kids, other relatives and friends can become tax deductions when they pitch in for trade shows and other activities they’re good at doing. Many of these are allowed at standard deduction rates. All of these benefits help small businesses net more profit. On the flip side, if your business experiences a net operating loss, you may benefit from a refund on your personal tax return.
When is a single-member LLC terrible for your tax bracket?
Any event that could ultimately and unexpectedly move you into a higher tax bracket could be considered terrible. Often, and the IRS is fully aware of this, the owner of a single-member LLC has a tendency to become complacent with even the most simple bookkeeping and tax records. By not paying close attention to business trends, not having a written business plan and goals, or a written business agreement (with yourself, and yes, there are benefits to this), year-end tax filing could yield some terrible surprises.
Near the tax bracket top can be a dangerous place
Special rules apply when your LLC has an operating loss. The amount of loss you can deduct may be limited by the At-Risk rules because of your limited liability for LLC debts. The absence of your anticipated deduction could be terrible for your tax bracket!
An individual owner of a single-member disregarded LLC who operates a trade or business is subject to the tax on net earnings from self-employment in the same manner as a sole proprietorship. A good year could become terrible!
An election to change classification from a disregarded entity to a corporation is treated by the IRS as if the corporation distributed all of its assets and liabilities to its single owner in liquidation. This could be terrible for your tax bracket!
Why choose a single-member LLC?
Before making this choice, especially if the main draws are lower cost, simplicity and independence, as your CPA, I strongly and seriously urge you to discuss this with me before making your final decision. A single-member LLC could be your perfect choice, but the reasons must go further. Why raise and wave red flags at the IRS?
Just like most everything, if there’s an UP there could be a DOWN, and business has many shades of gray. Are you 100% sure you know, and are using, every tax benefit provided by your business structure? Are you sure you know whether the UP or DOWN is better, and if either one is controllable?
The bottom line
If your business doesn’t deal with rental property and you’re considering a single-member LLC, we need to talk. Make a valid case for your decision to select a single-member LLC as your business entity.
We establish and maintain a business and personal relationship with our clients. We know that Your BUSINESS is Your Life, and Your LIFE is Your Business and we take both seriously.
You may also be interested in:
- how tax preparation and tax filing are different
- reading the IRS checklist for starting your own business
- why you should take your side hustle paperwork seriously
- great tax planning with the right business entity type