One of the most common types of small businesses in the U.S. is a single-member limited liability company (SMLLC), an entity that has one owner registered in the state where it does business.
This article discusses how to start an SMLLC, how it's taxed, and the advantages for solo business owners.
How a Single-Member LLC Works
The term "single member" is a recognition that the LLC has one owner, and that the owners of an LLC are termed "members." As a limited liability company, the single-member LLC has all the advantages of other LLCs.
How To Form a Single-Member LLC
To form a single-member LLC, you must file articles of organization (or a certificate of organization in a few states) with the state where you want to do business and pay a filing fee. After filing this state business registration, you should consider also preparing an operating agreement (similar to a partnership) to spell out how you will run this business.
You will also need to get an employer ID number (EIN) for your new business, even if you don't have any employees. In some states, you may need an EIN before you file your organization papers. You can apply online for the EIN, which is used for federal income tax and employment tax purposes.
Most single-member LLCs calculate their business income taxes on Schedule C of their personal tax returns, In this case, you must use your personal tax ID (not the EIN) when completing a W-9 form when you work as an independent contractor.
Single Member LLC vs. Sole Proprietorship
Registered with state
Seen as legitimate business
May not be seen as legitimate business
Advantages of Single-Member LLCs
While both the single-member LLC and the sole proprietorship are solo business entities, there are some advantages to the former:
- The SMLLC is now a separate business entity from its owner. It is no longer attached to and identified with the owner, and the owner's liability is limited to their investment in the business.
- The SMLLC is recognized as a legitimate business, separate from the owner, with the required "LLC" included in the business name.
- The SMLLC is formed within a state and part of the approval process is a registration of the business name, so no other business in the state may use that name. A sole proprietor may also register a business name with a state, but it's a separate process.
SMLLCs require more paperwork than if you were running a sole proprietorship. In addition to the articles of organization, you need to file an annual report and pay a fee with the secretary of state's office.
How a Single-Member LLC Is Taxed
An LLC is not a specific tax entity for federal income tax purposes, and most single-member LLCs pay income taxes in the same way as sole proprietors, by filing Schedule C as part of their personal income tax returns. The business Schedule C net income (profit or loss) is then combined with other sources on the owner's personal tax return.
SMLLCs are confusing because the IRS calls this business type a disregarded entity, which means that the IRS ignores the business for tax purposes and instead collects taxes through the Schedule C portion of the business owner's personal income tax filing.
Other Income Tax Options for Single-Member LLCs
A single-member LLC has the option of paying income taxes as a corporation or S corporation. To change its tax status to a corporation, the LLC must file an election with the IRS on Form 8832. To change tax status to an S corporation, you must file Form 2553. The timing of these elections is complicated, so get help from a tax professional.
The change from a single-member LLC to a corporation or S corporation only affects the business taxes. The business still continues to operate as an LLC.
Self-Employment Taxes for Single-Member LLC Owners
Single-member LLC owners, like sole proprietors, are considered self-employed and are not employees of their business. As self-employed individuals, single-member LLC owners must pay self-employment taxes (Social Security and Medicare taxes) each year, based on their net income from the business.
Frequently Asked Questions (FAQs)
How do you pay yourself with a single-member LLC?
A single-member LLC owner doesn't take a salary or wages from their business; you can take money out of the business at any time. These payments are called a "draw," because you are drawing money from your ownership in the business. It's important to remember that you get paid last, after all other business bills are paid.
You don't pay income tax on the amount you draw out of your owner's account every year. The business pays taxes on its net income (profit) each year, calculated on Schedule C of your personal tax return.
In addition to paying income tax on net income, you must pay self-employment tax for Social Security and Medicare taxes on the business's net income every year.
How do you close a single-member LLC?
Closing a limited liability company (LLC) is complicated, because you must comply with federal, state, and local requirements.
You must formally dissolve the business with your state by filing specific legal documents, which are different for every state. You must also notify your state's taxing authority for state income tax and sales tax purposes. Get help from a tax attorney to make sure this is done correctly.
You must also notify the IRS for income tax and employment tax purposes (if you have employees). Be sure to notify the IRS to cancel your Employer ID Number.
You may also need to notify your locality if you have a fictitious name (doing business as, or "DBA") registered.
How do you change your business structure to a single-member LLC?
The process of changing to a single-member LLC depends on what type of business you already have.
If your business is presently a sole proprietorship business, meaning you haven't registered with a state, you can go through the registration process for an LLC. To register your LLC, you need to file articles of organization with the state where you want to do business. You will also need to get a federal tax identification number, called an employer ID number (EIN) for the LLC.
If your business is presently a partnership or corporation, the process of changing the structure is more complicated. You will have to dissolve the previous business and then register the new LLC with your state.
In both cases, you'll need the help of a licensed tax attorney to make sure everything is done correctly.