Working for yourself is both rewarding and challenging. You’re in complete control of your business, but it can also be tough to get others to recognize you as a real business.
For some people, a limited liability company (LLC) provides a solution. An LLC can offer a bridge between operating as a sole proprietorship and acting as a corporation for tax purposes. And for individuals who are also their whole business, a single-member LLC (SMLLC) is a great place to start.
What Makes a Single-Member LLC Unique?
A single-member limited liability company is an LLC with only one owner (called a “member”). It functions much as any LLC would. In fact, as far as the government is concerned, single-member LLCs are just LLCs. The paperwork to create an LLC and a single-member LLC is the same.
Note that only being able to have one “member” doesn’t mean you can’t have employees — it just means you can only have one “voting member.” A voting member is a person with an ownership stake who makes major decisions for the business.
LLCs limit the liability of the owners. If the company takes on debt or declares bankruptcy, no owner is held personally liable. So, if two people open a bakery together, structure it as an LLC, and it goes bankrupt or gets sued, the owners won’t lose their houses or other personal property in the process. (There are exceptions, especially when business owners mix business assets and finances with personal property and accounts.)
If you create a single-member LLC, you can elect to be treated as a corporation, which means you’ll need to file a separate income tax return for the business. Otherwise, you’ll do the company taxes along with your personal taxes by attaching a Schedule C to your individual Form 1040.
Unlike sole proprietorships, LLCs file paperwork with the state and pay registration fees every year. Unlike corporations, LLCs don’t issue stock or keep formal meeting records.
LLCs are ideal for small businesses that face risks of bankruptcy, lawsuits, or other costly events. Typically, all you need to do is file Articles of Organization with the state, pay a filing fee, and keep up on your annual renewal fees.
Single-Member LLCs vs. Multiple Member LLCs
Aside from the obvious difference of one owner versus two or more owners, single-member LLCs (SMLLCs) and multiple-member LLCs (MMLLCs) have a few other distinctions.
For some small businesses, especially family businesses, the lines can blur regarding who is an owner. If you have more than one potential owner but are still considering a SMLLC, you should consider the following:
- SMLLCs have one owner, who is also the manager. MMLLCs can either be owner-managed (all members participating equally) or have a separate management position for one person. That manager can be one of the owners or a third-party.
- SMLLCs are taxed the same way a sole proprietorship is taxed, while MMLLCs are taxed like a partnership. Either way, however, the tax process is not independent of owners’ personal taxes.
- MMLLCs have more decisions to make and agree upon, as more people are involved.
A “Disregarded Entity”
If you choose to become a single-member LLC and don’t elect to be treated as a corporation, your SMLLC will become a “disregarded entity.” So, what does this term mean?
A disregarded entity is ignored by the IRS for tax purposes. The owner uses Schedule C of IRS Form 1040 to report and pay the business’ taxes as part of their personal taxes. Both federal income tax and self-employment tax must be paid.
Despite being a disregarded entity, an SMLLC must have a registered agent who will receive the company’s legal correspondence. Also note that if your SMLLC has employees, you’ll need to treat it as a separate entity for employment tax and some excise taxes.
Benefits of an SMLLC Over a Sole Proprietorship
For an individual who runs their own business, it might seem simpler to remain a sole proprietorship than to become a SMLLC. A sole proprietorship is the most basic business structure and requires no formal action to exist. Freelance contractors, for example, often maintain sole proprietorships.
Still, there are definite benefits to making the switch:
- The business will be officially recognized, as “LLC” must be in the company name.
- The business’ name will be registered with the state, meaning no other organization in the state can use that name. A sole proprietorship can register a name, but it’s a separate process, and few people use it.
- Owner and business are officially separate entities, which can provide the owner with peace of mind and protect their personal assets.
- Some business owners feel like their business seems more “official” when they have an LLC. You may even find that customers, clients, and potential partners take you more seriously once you’ve formed an LLC.
When to Transition from a Sole Proprietorship to an LLC
Perhaps you’ve maintained a sole proprietorship for a while now but are thinking about transitioning to a single-member LLC. What cues should you watch for?
- Your business is doing well, but the burden of having your personal assets on the line stresses you out.
- The risk of lawsuits or debt is becoming more significant (which can happen even for a healthy business).
- Investors like your business model but won’t get involved unless you make the company official.
- The paperwork, filing fee, and other legwork required to be a SMLLC are manageable and worth the effort.
When you’re ready to make the switch, make sure you research the filing requirements for your state. And if you need help with your business’ taxes, get in touch with the trusted, experienced professionals at S.H. Block Tax Services.
Contact S.H. Block Tax Services for Your Small Business Tax Needs
Whether you’re transitioning to a single-member limited liability company or ready to become incorporated, S.H. Block Tax Services is here to guide you. Our firm has more than 100 years of combined tax resolution experience, and we’re ready to advocate for your rights as a taxpayer.
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