Trusts are traditionally used to protect assets. Lately, family limited partnerships and family limited liability companies (LLCs) have become more popular. With the allowance of the single-member LLC, if you have been operating as a sole proprietorship or have formed a corporation, you now have an alternative. This can be an outstanding way to limit liability and protect personal assets.

LLCs and the Law

At least 41 states allow single-member LLCs. The remaining U.S. jurisdictions likely will recognize the limited liability of owners of single-member LLCs that are formed in other states. On Jan. 1, 1997, the federal government issued tax classification regulations commonly referred to as the “check-the-box regulations.” Under these regulations, the following rules apply to LLCs:

• LLCs are disregarded for federal tax purposes. Their income, losses and other tax items are attributed to the LLC owners unless the owners opt out by election.
• Tax items of a single-member LLC owned by an individual would generally be taxable to the owner as if the LLC were a sole proprietorship.
• Unlike a single-member LLC, a sole shareholder corporation owned by an individual can only be taxed as a C or S corporation and cannot opt to be taxed as a sole proprietorship.

For individuals who own a business, several factors favor single-member LLCs over sole shareholder corporations,while other factors favor single shareholder corporations.

Factors Favoring Single Member LLCs

Taxation. Under the check-the-box regulations, the income, losses and deductions of a single-member LLC will be taxed to the owner as if the owner operated a sole proprietorship, unless the single member elects otherwise. If, in the future, the single-member LLC takes on additional members, it will be taxed as a partnership. This is generally more desirable because C corporation income is subjected to two levels of tax.

Simplicity. In general, LLC statutory rules are easier to understand and apply than corporate rules. Also, there are no limitations or restrictions on the planning that can be done with a membership interest in an LLC. By contrast, the types of S corporation shareholders and the interests they can hold are limited.

Liability. The single member LLC offers its owner limited liability. In other words, the owner can lose the capital that he or she contributed to the company, but will not be personally liable beyond those contributions. The liability protection should not be less than that offered by a corporate structure. In fact, if the “corporate veil” is “pierced,” the corporate structure can result in greater liability.

Charging orders. Generally, LLC statutes allow judgment creditors of LLC members to obtain charging orders only against the members. Under a charging order, if the LLC makes a distribution of profits, the debtor members’ allocable shares of the distribution must go to the creditor. Thus, the creditor is not actually a member in the LLC but merely receives the distributive share. If no distributions are made, the creditor receives nothing.

Factors Favoring Sole Shareholder Corporations

Limited liability of owner a certainty. As long as the corporate veil isn’t pierced, the limited liability of owners of a corporation is unquestionable in all U.S. jurisdictions. By contrast, in certain jurisdictions, the limited liability of the member of a single-member LLC may be questioned.

Thus, the sole shareholder corporation might be preferable if the business owner:

• Wants absolute certainty of limited liability for business debts in all jurisdictions,
• Does business in a jurisdiction where the liability of the single member in the single member LLC is unclear, and
• Has significant concerns about being sued in one or more of these questionable jurisdictions.

Corporate shield. While adherence to corporate formalities is necessary in order to defend against piercing of the corporate veil, complying with these formalities can shield defendants against creditors.

Going public. Going public is easier through a corporation. If the business will go public, the business owner should consider forming a corporation.

Explore Your Alternatives

The single-member LLC presents a useful alternative to the sole shareholder corporation. The unique combination of legal and tax advantages available through an LLC often outweigh the advantages of operating in the corporate form.