Sole proprietorships are easy and cheap to form but don’t offer the limited liability or business legitimacy that many entrepreneurs want. If you’re the sole owner of your business, you can’t form a traditional LLC, but you are eligible to be a single-member LLC. The single-member LLC is simpler to maintain than a traditional LLC and still offers some benefits of limited liability. Here’s why it’s a sensible business format for solopreneurs.
One benefit of an LLC is the minimal regulatory requirements. To set up a single-member LLC, you must draw up articles of incorporation, file them with your secretary of state’s office, and pay a small fee. Past that, compliance requirements are minimal. An S corporation, on the other hand, must observe certain corporate formalities. S corporations are required to elect directors and officers, hold periodic reelections, and hold an annual meeting of the board and stockholders. Single-member and multiple-member LLCs don’t have these requirements.
Taxes and Other Expenses
Keeping up a single-member LLC is even easier and cheaper than maintaining a multiple-member one. Like a traditional LLC, a single-member LLC can elect to be taxed as a corporation. If you don’t make this election, however, your single-member LLC is treated as a “disregarded entity.” In other words, you won’t be required to file a separate tax return for your LLC. Instead, you can continue to report your self-employment income on Schedule C and save on tax preparation fees. You also won’t encounter any minimum tax fees for operating a single-member LLC. If you’re in a state with a high minimum tax fee for traditional LLCs — California’s minimum tax is a whopping $800 a year, for example — you can potentially save hundreds of dollars.
Single-member LLCs offer limited liability protection, but the protection isn’t as robust as it is for traditional LLCs. Theoretically, the owner of a single-member LLC has limited liability for business debts, so the LLC can’t be held accountable for the owner’s personal obligations. However, any business owner’s liability protection may be overturned by a court. Limited liability is based on the idea that the company and the individual are two separate entities. Since a single-member LLC is a disregarded entity, owners are less likely to keep personal and business affairs separate and a court may be more likely to pierce the corporate veil.
State laws also offer more protection to multiple-member LLCs. According to Mark Kohler, an attorney and CPA who specializes in business and taxes, 18 states disallow plaintiffs from accessing property in an LLC to satisfy personal obligations but only three states afford this legal right to a single-member LLC.
To keep your liability protection intact, Kohler recommends that single-member LLC owners maintain a formal operating agreement that governs how the LLC functions.
Choosing a Single-Member LLC
Even though the liability protection isn’t completely ironclad, the single-member LLC still makes sense for many entrepreneurs. You’ll be able to put “LLC” behind your name, which will make some customers and vendors take you more seriously, with less cost or effort than if you establish an S corporation.
If and when you’re ready to graduate and convert to a traditional LLC or S corporation, it’s fairly easy to make the switch. Kohler points out that single-member LLCs can make a retroactive election to become an S corporation if they want to avoid self-employment tax for that year. If you decide you want the protection of a multiple-member LLC, you can issue a small amount of membership interest — say, 2 percent — to a close family member and convert your status.