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An SMLLC combines the limited liability of a corporation with the tax benefits of a sole proprietorship.
A single-member limited liability company (SMLLC) is a single-owner business entity that gives the owner limited liability protection and tax benefits. (“Limited liability protection” means that if the business is sued or owes money, your personal assets will usually not be at risk.) If you already have a sole proprietorship, you might have the option to convert the business into an SMLLC by filing the appropriate paperwork with the state. After you form an SMLLC, you’ll need to treat it as a separate business entity in order to maintain your liability protection.
Sole Proprietorship, Single-Member LLC, and Multi-Member LLC: What’s the Difference?
As soon as you begin a business on your own, and in some states with your spouse, you’re operating a sole proprietorship. In the eyes of the law, there is no difference between the owner and the business. If a sole proprietorship owes a debt, so does the individual. Bringing a lawsuit against a sole proprietorship is the same as suing an individual.
In contrast, an SMLLC is a separate business entity that the owner forms by filing paperwork with the state. The business owns property and takes on obligations. If someone sues the company, the owner’s assets (like a car or bank account) will not be on the line to satisfy the debt. Like a sole proprietorship, an SMLLC has only one owner. In some states, when a husband and wife are the owners of an LLC, the law considers the company to be single-owner, while other states would consider the company a multi-member LLC.
A multi-member LLC is the same as an SMLLC, but with two or more owners. The owners enjoy limited liability and the same tax benefits as SMLLC owners (as discussed below). When a company has more than one member, the owners decide how to share management responsibilities and split profits and losses.
How Is a SMLLC Taxed?
By default, the IRS taxes an SMLLC the same way as a sole proprietorship, as a pass-through entity. As “pass-through entity” is a business that does not pay corporate tax. The income flows through the business and is imputed to the owners, who pays tax for the first time on their personal tax returns. An SMLLC does not submit a separate tax filing (as opposed to corporations). The owner reports income and expenses from the SMLLC on a Schedule C, which is an attachment to the personal tax return.
In some states, the SMLLC might be responsible for state franchise tax or corporate tax, and a separate tax filing. LLC owners pay federal self-employment tax, which includes Social Security and Medicare, on all income from the company.
An SMLLC can elect C Corporation or S Corporation tax status by filing additional paperwork with the IRS. For more information on why you might elect a different tax status and the steps for filing, see our article, The Benefits of S Corporation Status.
How to Form an SMLLC
Forming an SMLLC is much like forming a multi-member LLC. Each state has its own forms and rules for filing. The steps typically include:
- Choosing a name for the company that is available and complies with state laws. Some states require you to include “Limited Liability Company,” “LLC,” or a similar abbreviation. Use your state’s business search tool to determine if the name is available.
- Filing articles of organization, also known as articles of incorporation, with your secretary of state, and paying the filing fee.
- Registering with state and federal tax agencies, when required.
- Obtaining business licenses and permits.
- Drafting an operating agreement.
Does an SMLLC Need an Operating Agreement?
An operating agreement provides the internal rules for managing the company. For multi-member LLCs, operating agreements can help to avoid and resolve conflicts among owners. Importantly, the agreement should specify how to split profits and losses. Even though an SMLLC has only one owner, the company can also benefit from having an operating agreement. Some states require all LLCs to have agreements, and many banks require one to open an account.
Having an operating agreement that you follow will help you maintain your limited liability protection should you need to assert it. The agreement demonstrates that you are treating the company as a separate business entity, and not like a sole proprietorship.
Finally, an operating agreement gives you a place to record the current state of the company and address issues that could arise in the future. For example, in the agreement you could include your initial financial contributions, and whether you will manage the business yourself or bring on someone else to handle the day-to-day affairs. The agreement may provide what will happen to the company if you become incapacitated or die — will the company dissolve, or will you designate someone to take over the business?
Does an SMLLC Need an Employer Identification Number?
An employer identification number (EIN) is a unique tax identification number, assigned by the IRS. You will need an EIN if you elect corporate taxation or if you have employees. Otherwise, an EIN is optional for SMLLCs. However, if you do not have an EIN, you will use your social security number on your tax filings and your business bank accounts. Some SMLLC owners obtain an EIN to protect their personal information. The EIN application is free, and you can complete the application online in a matter of minutes.