By Jennifer Reuting, author of Limited Liability Companies for Dummies™
Limited-Liability Companies are traditionally just partnerships, with added liability protection. Because of their partnership origins, operating an LLC with only one owner (called a Single-Member LLC) can cause some hiccups.
In fact, the IRS considers single member LLCs to be "disregarded entities" and taxes them as they would a sole-proprietorship. You see, because LLCs were designed to be partnerships, the IRS only agreed to recognize the new entity type under the condition that you adhere to some basic partnership rules - namely that you have a partner! And no, your dog doesn't count…
Why a Single Member LLC isn't a good thing…
To fully understand why operating as a single-member LLC can be dangerous, you first have to understand what it is you have to lose. The primary advantage that LLCs have over corporations and other incorporated entities is charging order protection. In addition to the basic level of liability protection offered by most incorporated entities, where your personal assets can not be seized to settle the debt or obligation of the business, the LLC offers a second level of liability protection called charging order protection. This second layer of protection prevents your (or your partner's) personal creditors from seizing your business or its assets to settle your personal debts.
Because LLCs are traditionally partnerships, charging order protection was created to protect your business partners from your own personal misfortunes. For instance, if your membership in the LLC was seized, all of a sudden your partners would have to deal with a new partner - whether it's the bank, the federal government or an individual you owed money to, it's still someone that the other partners didn't approve. To prevent this from occurring, the federal government stipulated that personal creditors cannot seize the partner's LLC interests but can only obtain a charging order and receive the percentage of the profits allocated to them - profits which you control.
The best and easiest way to avoid operating as a single member LLC is to take on a partner. Even if you only give two percent of the company away to a close family member, you'll still be in the clear. Keep in mind, though, that if you choose your spouse as your only partner, the IRS (and most likely, the courts!) will still consider you as one member. However you can choose a child or another relative with no problem.
If you choose your spouse as your only other partner in your LLC, the IRS, and in most cases, the courts, will still consider you as one member.
When choosing another partner, keep in mind that your partner is NOT required to also manage the LLC. You can force them to remain silent by setting up your LLC to be manager-managed and then choose yourself as the sole manager. That way, you can limit the exposure your second partner has to the day-to-day business operations and keep all of the decision-making power to yourself.
Sometimes people just can't muster the strength to give away a small percentage of their company that they've worked so hard to build. And it's understandable… you've toiled day in and day out - why should you give two percent to someone that hasn't struggled, persevered and navigated the minefield of business ownership? If you just can't seem to do it or don't have anyone in your life you wish to endow with this sort of gift, then there are ways to substantiate yourself as an incorporated entity in the eyes of the IRS and the courts, which will assist you if and when the worst occurs.
Remember, if you take on a partner whom you wish to remain silent, then form your LLC as member-managed, then your silent partner now has the same decision-making power as you, so Always choose manager-managed!
By following these simple suggestions, you can protect yourself - and your partners!
