Every year when tax season rolls around, sole proprietors face the same question: Is a single-member LLC worth it? Could I have saved money by setting up an LLC? If you have faced these very questions, you are not alone! We’re here to help unravel the pros and cons of a single-member LLC versus a sole proprietorship so you can make a more informed decision about the future of your business.
A single-member LLC is simply a limited liability company (LLC) that has only one owner, also called a member. Forming a single-member LLC follows the same steps you would take to form an LLC, by registering with the state in which the business operates.
Establishing a single-member LLC means that you can hire employees, and you can also choose to be treated like a corporation. This will impact how you file your taxes as you will file an income tax return for the LLC separate from your personal tax return.
The other main difference between a sole proprietorship and a single-member LLC is that you will need to annually file paperwork and pay registration fees with your state in order to keep the business operating.
The main difference between an LLC and a single-member LLC is the number of members, or owners, who are involved with the business. As a single-member LLC, you are both the sole member and also the designated manager of your LLC.
LLCs with multiple members or partners can choose to be structured in a few different ways:
- Owner managed, meaning every member participates equally in the management of the LLC.
- Managed by only one member, with the other members playing different roles.
- Managed by a third-party (non-member)
Taxation is also a distinguishing difference between a single-member LLC and a multiple-member LLC. When an LLC has more than one owner, it is typically taxed as a partnership. Both an LLC and a single-member LLC can elect to be taxed like a corporation, as we mentioned above.
What is a “Disregarded Entity?”
If you form a single-member LLC and choose not to be taxed as a corporation, you become a “Disregarded Entity.”
“Disregarded Entity” is a term used by the IRS that simply means they ignore your LLC status for tax purposes. As a disregarded entity, your single-member LLC is taxed in the same way a sole proprietor is taxed—you pay your taxes by filling out a Schedule C that is attached to your personal tax return.
However, if you have employees, you will file and pay employment and applicable excise taxes through the LLC, not your personal tax return.
Many sole proprietors question whether a single-member LLC is worth it. There are several pros and cons of a single-member LLC which may help you in your decision about the future of your business.
In many cases, having an LLC makes it easier for business owners to open a business bank account, apply for business loans, and establish a reputation as a legitimate business among clients and vendors. The pros of single-member LLCs, however, don’t stop there.
Asset & liability protection
One of the biggest reasons to switch from a sole proprietorship to a single-member LLC is to protect your personal assets. Should your LLC ever be sued, your home and other personal assets would be protected. Only the assets of the LLC would be at risk.
Pass-through taxation as a disregarded entity
Pass-through taxation is what you experience as a sole proprietor, and it is also a benefit of a single-member LLC. Your income from your business passes through to your personal tax return and doesn’t face traditional business taxes. Instead, you are only responsible for paying federal income and self-employment taxes.
Easier transfer of ownership compared to a sole proprietorship
Should you decide to sell your business, or step into a new role and transfer ownership to another company or individual, the legal process is much easier to complete as a single-member LLC. Because you are already established as an LLC, the paperwork and process to transfer ownership are already in place.
Ability to elect for S Corporation taxation
When filing taxes as an S Corporation, you can save on Medicare and Social Security taxes. While the amount you elect to pay yourself as a salary will be taxed like any other income, the remaining profits in your business can avoid those taxes. The LLC can pay the remaining profits to you (the owner) as a dividend, which avoids Medicare and Social Security taxes.
While there are benefits to setting up a single-member LLC, it may not be the best option for everyone. It certainly isn’t a one-size-fits-all business solution.
There are three main reasons you may want to keep operating as a sole proprietor rather than switching to an LLC.
- Extra costs associated with establishing an LLC:
- Initial filing costs
- Paying annual registration and franchise tax fees
- Annual paperwork filed with the state as well as additional tax documents.
- Potential to pierce the corporate veil
Apart from the extra costs and administrative tasks associated with an LLC, single-member LLCs are sometimes not as protected from liability. When members establish a single-member LLC but don’t create an operating agreement or separate their personal and business finances, they could pierce the corporate veil and become personally liable for an incident related to the business.
If you’ve been considering a transition to a single-member LLC, but aren’t sure when to take the leap, here are a few indicators that it’s time.
- Vendors, clients, or investors won’t take your growing business seriously unless it is made “official”
- You’ve grown to the point that the cost and extra steps of starting an LLC are no longer a concern
- The growth of your business and your personal finances has you worried about how to protect your personal assets
- An increased risk of lawsuits related to your business requires separating your personal and business assets
- You want to take on some business debt (loans or lines of credit) without being personally liable
Do any of these apply to you? Take the next step for your business by following our step-by-step guide to change your sole proprietorship to a single-member LLC!