A limited liability company is a common business structure which combines the limited liability of a corporation with the flexibility of a partnership. State law regulates the formation and management of LLCs. A single-member LLC may function similarly to a sole proprietorship in terms of management and taxation; however, the owner is usually not personally liable for the debts and obligations of the business.
Every state has an LLC statute which sets forth how an LLC may be formed. As the sole owner of an LLC, you may hire employees or independent contractors to help run the business. However, you will be solely responsible for managing the business. The LLC provides limited liability for the owner, who is not personally liable for the debts and obligations of the business.
The IRS does not recognize LLCs as a business entity, but instead requires owners to choose how they want to be taxed. A single-member LLC can choose to be taxed as a sole proprietorship or a corporation. As a sole proprietor, the IRS recommends you report the income from the LLC on Schedule C of your 1040. You may be required to pay self-employment tax. However, a sole proprietorship is a disregarded entity, meaning that business owners do not pay corporate income tax before paying personal income tax. Conversely, if you report your income as a corporation, you will pay corporate tax in addition to personal income tax.
Effects of IRS Classification
Choosing a non-LLC tax format does not change the legal nature of an LLC. If you choose to be taxed as a sole proprietorship, this does not change the fact that you own an LLC or change the business type into a sole proprietorship. You would still enjoy limited liability and the same management structure, even if you choose a different entity for taxation purposes.
Single-Member LLC Precaution
Independently-owned LLCs should be aware that if they do not take adequate precautions, they may be liable for the debts of the business. In some cases, when a single-member LLC does not adequately capitalize a business or mixes personal assets with the assets of the LLC, a court will treat the business as a sole proprietorship and strip the owner of limited liability protection. A company is adequately capitalized when it has enough money and assets to independently function as a business. As such, owners of single-member LLCs may want to take extra steps to ensure their business has enough capital to function independently and they adequately maintain a separate and distinct identity from the business.
Elizabeth Rayne earned her J.D. from Penn State University and has been practicing law since 2009, advising clients on issues ranging from employment law to nonprofit management. For two years, she served as a contributing editor for the "Vermont Environmental Monitor."