LLC Attorney Takeaways:
- Single-member LLCs are permitted in all U.S. states except Massachusetts.
- Because they are disregarded for federal income tax purposes by default, single-member LLCs provide state-law liability protection without introducing tax complexity.
- Single-member LLCs are the preferred choice of entity for one-owner businesses.
The term single-member LLC refers to an LLC with only one owner (member). Single-member LLCs are the most popular form of business for one-owner business. They provide state-law liability protection at no tax cost and can be adapted to almost any use. This article discusses the use of single-member LLCs as a business vehicle.
Historical Background of Single-Member LLCs
LLC law is based on partnership law, and the foundation of partnership law is the partnership agreement. As the name suggests, a partnership agreement requires at least two partners to agree to it. The requirement that an LLC have at least two owners was pulled from partnership law into LLC law.
From the time that Wyoming adopted the first American LLC act in 1977 until 1992, all state LLC acts required at least two members. That changed when Texas first allowed single-member LLCs in 1992. Other states quickly followed suit. Today, single-member LLCs are allowed in all U.S. states other than Massachusetts.
Tax Classification of Single-Member LLCs
Single-member LLCs are one of a handful of disregarded entities—entities that are recognized for state-law purposes but disregarded for federal income tax purposes. Although the LLC may elect to be taxed as a C corporation or S corporation, most accept the default classification as a disregarded entity. As detailed in our discussion of disregarded entities, disregarded entity classification provides tax and asset protection planning opportunities.
When an entity qualifies as a disregarded entity—either through having one actual owner or through having multiple owners that are treated as one owner—the IRS simply ignores it. All income and loss from the LLC is reported on the owner’s income tax returns. The LLC need not file a separate tax return.
Uses of Single-Member LLCs
Single-member LLCs are popular tools for accomplishing business and asset protection planning goals. They are often used in three contexts:
- One-owner operating businesses. A single-member LLC is an effective, tax-flexible form of business for one-owner companies. Without the single-member LLC, the owner would either need to operate as a sole proprietorship, which offers no liability protection, or as a corporation, which subjects the owner to double taxation and includes onerous corporate formalities.
- Liability protection. A single-member LLC provides the same protection against inside liability as multi-member LLCs. A one-owner business can form a single-member LLC to eliminate personal liability for the debts and obligations of the business.
- Asset segregation. Single-member LLCs are often used as part of a holding company structure to segregate the assets and liabilities from each other for asset protection purposes. Because each single-member LLC is disregarded for tax purposes (see below), forming separate LLCs for each risky asset or line of business can protect assets without adding tax complexity.
The one downside of single-member LLCs is uncertainty regarding charging order protection. Charging order protection prevents a business owner’s non-business creditors (i.e., personal creditors) from seizing control of the LLC to satisfy a judgment against the owner. Beginning with In re Albright, 291 B.R. 538 (2003), federal bankruptcy courts have held that the rationale behind charging orders is to protect the other, innocent members of an LLC from economic hardship, and that rationale doesn’t apply if the LLC has only one member.
While concerning, the lack of charging order protection is not as severe as it may first appear and has not curbed the popularity of single-member LLCs. The lack of charging order protection is also mitigated by state law provisions that extend charging order protection to single-member LLCs. In these states, charging order protection is only an issue if the LLC member is already in bankruptcy in a federal bankruptcy court. State-law protection remains in place.
More importantly, any issues with charging order protection deal only with protecting the LLC’s assets from the member’s debts (outside liability). Most LLCs are formed for the opposite reason—to protect the member’s assets from the LLC’s debts (inside liability), and that protection is not in question: All state LLC acts (other than the Massachusetts act, which does not permit single-member LLCs) recognize LLCs as protecting the owner from debts and obligations of the LLC.