What is a single-member LLC?
A single-member LLC (SMLLC) is a limited liability company with one owner and is one of the most common types of small businesses in the U.S. (“Member” is the term used to describe the owner of an LLC.)
An LLC exists separately from its owner. It is a business entity that offers limited liability protection, which limits an owner’s personal responsibility for business debts and liabilities to only what they’ve invested in the LLC. It also offers pass-through taxation, meaning the LLC itself does not pay taxes. Instead, the LLC’s profits and losses pass through to the owner, who reports them on their personal income tax return.
The term “single-member LLC” is used to distinguish it from a multi-member LLC, which has more than one owner. A single-member LLC has the same advantages and disadvantages as a multi-member LLC.
Advantages of a single-member LLC
There are a number of benefits to forming an LLC vs. operating as a sole proprietorship.
Personal asset protection
Limited liability is the main advantage a single member LLC has over a sole proprietorship. A single-member LLC is generally shielded from personal liability for debts associated with the business. Because the LLC owns the business, and not the member, if an LLC owes money to a creditor, the creditor must look to the LLC to satisfy the debt. The personal assets of the LLC’s owner is protected.
Note: Single-member LLCs must be careful to avoid commingling business and personal assets, or otherwise disrespecting the separate existence of the LLC. If an LLC’s creditor tries to collect the debt from the member, and the member disrespected the separate existence of the LLC, that could lead to a court piercing the corporate veil – and holding the member personally liable for the debt.
Tax flexibility
For tax purposes, the IRS treats a single-member limited liability company by default as a "disregarded entity". That results in it being taxed the same as a sole proprietorship. The business income tax obligations automatically become the owner’s.
However, you can elect to have a single-member LLC taxed as a C corporation or S corporation instead. This option is not available if you operate as a sole proprietorship. (Note that if an LLC chooses to be taxed in the same way a C corporation or S corporation is taxed, it still is an LLC. That election is for income tax purposes only and has no effect on the type of business entity the LLC is.)
Other single-member LLC benefits
Other benefits of forming a single-member LLC include the following:
- High-risk businesses. LLCs can be a good choice for medium- or higher-risk businesses and for owners with significant personal assets they want to protect. This is because owners are shielded from personal liability as recourse for the acts of the LLC. An LLC’s creditors must seek recovery from the LLC itself to pay the debt, not the LLC’s owners. Therefore, your personal assets, like a home or savings account, are protected.
- Separate legal entity. An LLC is a legal entity that is separate from the owner in the eyes of the law. This means your LLC is held accountable for its actions when entering into agreements or contracts, acquiring debts or otherwise taking on business obligations.
- Credibility. Starting an LLC may help a new business establish credibility more so than if the business is operated as a sole proprietorship.
- Pass-through taxation. LLCs do not pay taxes at the business entity level unless they choose to do so. Any business income or loss is reported on the single member’s personal income tax return and any tax due is paid at the individual level.
Disadvantages of a single-member LLC
While there are many good reasons to choose a single-member LLC for your business, there are disadvantages to be aware of as well.
Compliance costs and responsibilities
One drawback of a single-member LLC over a sole proprietorship is the cost of maintaining business compliance. Unlike a sole proprietorship, an LLC is a statutory entity – meaning it is formed under and governed by a state LLC statute. And those statutes impose formation fees, as well as ongoing fees such as annual report fees and franchise taxes.
Before you file the documents to form your LLC, you’ll need to select a registered agent. This person, which can be an individual or a business entity, receives legal documents and official communications on behalf of your LLC. The registered agent must be located in the state, have a physical location, and be available during the appropriate business hours. Many LLCs select a professional registered agent rather than having the owner or an employee be the registered agent, as there are a number of advantages to doing so, even if it requires an extra fee. The registered agent’s name and address must be included in the formation document.
There are additional requirements for a single-member LLC, including, but not limited to the following:
- Naming restrictions. Every state has certain rules and regulations associated with naming your single-member LLC. Your LLC’s name must include words or abbreviations that indicate the type of entity it is such as “LLC” or “Limited Liability Company”. There are also certain words or phrases that are prohibited or that require approval to use. Your LLC’s name will also have to be different from the names of other domestic and foreign LLCs and other business entities that are on file with the business entity filing office.
- Publication requirement. Depending on your state, you may need to also file with the county, or publish notice of your LLC formation in a local newspaper, or file an initial report.
- Filings. In most states, you will also be required to complete periodic filings, such as those for annual or biennial reports, and pay franchise taxes. These extra filings and costs vary from state to state, making it important that you’re aware of all potential requirements.
- Expansion into another state. An LLC that transacts business in a state other than its formation state will be required to “qualify” or “register” to do business there. That brings on additional costs and compliance obligations.
Finally, be aware that inadvertent administrative dissolution can happen easily if you’re not clear on the laws regarding your LLC duties. For example, if you thought that because you didn’t have to pay state income tax, you don’t have to pay franchise taxes either, and you fail to pay the franchise taxes, your LLC could be administratively dissolved by the state.
Forming a single-member LLC
The steps for forming a single-member LLC are the same as forming an LLC with multiple owners. Each state has different requirements for forming an LLC, but key steps include choosing a formation state*, selecting a name for your LLC that meets the state’s requirements, and filing formation documents (known in many states as Articles of Organization) with the state Secretary of State (or equivalent office).
* You can form your LLC where you do business or in a different state than where you do business.
Each state other than where you initially formed your LLC is a “foreign” state. You are required to foreign qualify in those states in order to do business there. This generally requires filing an application for authority with that state’s business entity filing office and maintaining a registered agent in the state.
For more information, see Guide to forming an LLC.
What is a sole proprietorship?
Sole proprietorships are the most basic form of business structure. If you don’t form a business entity through a state filing (as with an LLC or corporation), but just start conducting business by yourself, you're automatically considered a sole proprietorship. This means
- Your business is owned by one individual proprietor (owner)
- Your business is not an entity separate and apart from its owner
- Your business’s assets and liabilities are not separate from your personal assets and liabilities
Because there is no separation between personal and business assets, you can be held personally liable for the debts and obligations of the business, which is the main disadvantage of operating as a sole proprietorship as opposed to an LLC.
DBA and sole proprietorship
A sole proprietorship is a type of business structure. Your choice of business structure (whether it’s a sole proprietorship or a statutory entity like an LLC or corporation) affects how you pay taxes, your business formation and post-formation requirements, how you manage the business, and your personal liability.
A DBA (doing business as) is not a business structure. It’s a name that business is conducted under other than the legal name of the business’ owner. In the case of a sole proprietorship, if business is conducted under a name other than the sole proprietor’s name, an official filing with the local and/or state government is usually required to inform the public that the business is operating under a name other than its legal name. A DBA is also called an assumed, fictitious, or trade name.
Advantages of a sole proprietorship
Sole proprietorships are ideal for low-risk businesses and entrepreneurs who want to test their business idea before pursuing a formal entity formation option. As such, there are many advantages.
- Cost. There is no cost to establish a sole proprietorship, which makes it a popular option for entrepreneurs with little to no funding.
- Control. The owner maintains 100% control and ownership of the business. A sole proprietorship can have only one owner, and that owner is entitled to the profits and control of the business.
- Maintenance. A sole proprietorship is easy to dissolve once the business closes. By definition, when you stop doing business you no longer have a sole proprietorship, but you do need to remember to cancel all licenses and registrations that are associated with the business. This includes canceling your DBA (doing business as) name if you registered a DBA name for your business.
- Taxes. Filing tax forms is easy. Simply complete the IRS Schedule C.
Disadvantages of a sole proprietorship
It’s important to consider the disadvantages of a sole proprietorship. While the financial savings are appealing, there are drawbacks to this business structure.
- Liability exposure. The most significant disadvantage of a sole proprietorship is your exposure to liability as the business owner. You are personally liable for any debts or obligations of your business, so if the business can’t cover its debts, creditors or lawsuit claimants can seize personal property and funds from your personal accounts.
- Raising money. You may struggle to raise money because, with a sole proprietorship, you can’t sell stock. Banks are also often reluctant to lend to sole proprietorships, making it difficult to get a loan.
- Rigid ownership rules. If you want to bring in another owner, you’ll need to register for an EIN (Employer Identification Number). By bringing in another owner, you go from a sole proprietorship to a general partnership. You are no longer the sole owner, and as a result, cannot be registered with your social security number. In addition, you’ll also need to report both earnings and losses with Form 1065 – US Return of Partnership Income, and file individual K-1s to cover each partner’s portion.
- Business lifespan. A sole proprietorship ceases to exist upon the retirement or death of the owner.
Forming a sole proprietorship
There's no formal registration process for establishing a sole proprietorship. You automatically become a sole proprietor the moment you start doing business by yourself without forming another entity type. Keep in mind that you may have to fulfil any legal obligations that may be required, such as obtaining a business license. For more information, see How to start a sole proprietorship.
Comparing LLC and sole proprietorship: The similarities
A single-member LLC has its advantages, as does a sole proprietorship. There are many similarities between these options as well, from the way they are controlled to the way they are taxed. Get all the facts before making your choice.
- Tax obligations. Whether you’re a sole proprietor or the owner of a single-member LLC, you’re required to report your income and expenses on Schedule C of Form 1040. The net income will be taxable to you regardless of whether you withdraw cash from the business or not.
- Recordkeeping. Business expenses will be deductible against your gross income and not as itemized deductions. As such, it’s important that you maintain complete records of your income and expenses. This ensures that you can take the full amount of the deductions that you’re entitled to.
- Employees. If you hire any employees, whether you have a sole proprietorship or an LLC, you need to acquire a taxpayer identification number, in addition to withholding and paying payroll taxes. Without employees, your social security number is your taxpayer identification number. Although you will still have the option of obtaining an EIN if you don’t want to use your SSN or need one for banking for state tax purposes.
- Licenses and permits. When it comes to business licenses and permits, both an LLC and a sole proprietorship require you to keep up with those obligations. Note that state and local governments, like counties, cities or towns, usually impose business license requirements. In some cases, the federal government does, too. You need to be aware of all business obligations, regardless of whether you choose an LLC or sole proprietorship.
- DBA option. As a sole proprietor, you can choose to do business under your own name, or you can choose an “assumed business name”, also referred to as a DBA (Doing Business As), d/b/a or fictitious name. Similarly, with a single-member LLC, you can do business under the legal name of the LLC, which is the name on its formation document. Or, you can have the LLC do business under a different name, which will then require the LLC to register its own DBA name.
- Control of the business. In the case of both a sole proprietorship and a single member LLC, the sole proprietor/single member can make all the day-to-day and long-term decisions for the business. However, an important distinction is that in the case of the LLC, the decisions are made in the name of the LLC, not the individual owner.
Differences between LLC and sole proprietorship
There are important differences between LLCs and sole proprietorships. The most significant difference is whether you have limited liability for the business’ debts and obligations, as with an LLC, or whether the business’ liabilities and obligations fall to you personally in the event of a lawsuit or debt collection.
- Legal protection and liability. An LLC has distinct advantages in the areas of legal protection and liability. While there are filing fees for setting up an LLC, that cost can be well worth it when compared to the unlimited liability you could face as a sole proprietor.
- Dissolution. Dissolving a sole proprietorship business is as simple as stopping operations (and canceling any licenses and permits). To dissolve an LLC, you’ll have to follow the procedure outlined in the state LLC law, including filing documents with the state to make the dissolution effective.
- Regulatory requirements. Because sole proprietorships are not formed under, or governed by a state business entity statute like an LLC, sole proprietorships are subject to fewer regulatory requirements. LLCs are required to make a number of filings and pay a variety of fees, both initially and ongoing, with the Secretary of State (or equivalent office) where the LLC was formed.
Summary
When deciding between a single-member LLC and a sole-proprietorship, focus on the needs of your business. As an entrepreneur testing the waters, a sole proprietorship may be an easy and cost-effective option, while a fast-growing business that needs funding would be better suited to an LLC. Consider your business objectives when reviewing your options, from financial to operational, to make the best choice for you and your business.
