One of the most popular types of business entities in the United States is a single-member limited liability company.
This type of LLC has only one owner. A single-member LLC is usually a business registered in the state where the company does business.
The phrase “single member” is an admission that the LLC has one owner, and that owner is referred to as a member.
A single member LLC has so many benefits that are shared with other LLCs.
So in this post, we’re going to break down some of those advantages and disadvantages of a single member LLC in 2021.
We will also be discussing a typical operating agreement, how taxes work, and compare it against sole proprietorship.
Let’s first dive in by quickly looking at what an LLC is.
What is an LLC?
LLC stands for limited liability company which is simply a type of business entity you can create when you choose to go into business.
Examples of other entities would be:
- sole proprietorship
- limited partnerships
- general partnerships
All these business entities have their own unique advantages and disadvantages.
And LLCs are most known for their advantage of separating business assets from personal assets. Thus, protecting personal assets from business-related liabilities.
An LLC with multiple owners is typically known as a partnership LLC.
And as we mentioned, an LLC with one owner is known as a single member LLC that is sometimes referred to as an SMLLC.
How a Single Member LLC is Formed
So if you want to start a business and believe that a limited liability company is the best entity type for you, then you must go to your state’s business division to gain information about their specific process.
Usually, this involves going to the secretary of state website, filing for the Articles of Organization (or Certification of Organization in a few states).
And then paying a filing fee ranging from $100 – $200.
Along with registering your business in your state, you may want to consider filing an operating agreement.
The Articles of Organization tell the state the new SMLLC exists, puts it in the public eye, and shows people how to contact the business.
On the other hand, the operating agreement lays out the most important rules for how an SMLLC will be run.
Generally, the operating agreement is not required to form an SMLLC, although it is RECOMMENDED.
That’s because a single member LLC operating agreement offers various benefits such as:
- Providing rules that will supersede the default provisions of your state’s LLC Act.
- Serving as an additional document to show potential lenders regarding the organization of your business.
- Particularly for manager-managed SMLLCs, specifying who will take over management of the business in the event the owner becomes incapacitated or dies
- Providing an additional affirmation of the separation of your business from you personally.
- Providing a point of reference for how you originally intended to operate the business.
- Some banks that you want to work with will expect you to have an operating agreement.
Benefits of a Single Member LLC
Now you may be thinking that a sole proprietorship and SMLLC is quite similar, but here’s where the SMLLC wins.
The single member LLC is a separate business entity from its owner. It is no longer attached to and identified with the owner for tax or liability purposes.
An owner of an LLC is recognized as a legitimate business, due to the popularity and requirement of “LLC” included in the business name.
When a single member LLC is formed within a state, part of the approval process is business name registration, which protects any other business in the state from using that name.
So those are some of the major pros of a single member LLC, but of course, a single member LLC is not for everyone and there are definitely some cons.
Now, we won’t cover that here because we already have a post comparing LLCs to S-Corps, so be sure to read it next.
And also, we have a more detailed post on the benefits of an LLC if you want to learn more about limited liability companies.
However, one special thing to note regarding SMLLC is that they are the most common type of disregarded entity.
This basically means that the IRS can ignore the business for tax purposes and instead collect taxes through the business owner’s PERSONAL income tax filing.
How a Single Member LLC is Taxed
1. Pass-through Taxation
Now because SMLLC can be classified as a disguised entity, the responsibility for paying income taxes is passed through to the owner.
This way of taxing profits is known called pass-through taxation which then references LLCs as pass-through entities.
The primary business taxes you will pay are federal income taxes and self-employment taxes.
To report and pay federal income taxes on your single member LLC business, you will need to complete a Schedule C, which is a profit or loss business form.
This is attached to your personal federal tax return that you file with the IRS.
Schedule C will report all your business transactions such as income, expenses, assets, and profits.
That’s why it’s critical as a business owner that you are keeping track of your transactions throughout the year, in preparation for the tax season.
Here’s an example that will help make single member LLC taxes clear.
Let’s say that Mary has an SMLLC for her part-time, home-based bakery business.
Last year, she earned a total of $40,000 from the business and had expenses totaling $10,000 for supplies, equipment, and other items.
She also earned $25,000 from her part-time job as a consultant. Mary will use Schedule C to show her income and expenses on her home bakery business.
She attaches Schedule C to her personal tax return, where she will report and pay taxes on her combined net income of $55,000 ($30,000 from her bakery and $25,000 from her part-time job).
Now one last thing you need to know about single member LLC taxes is that you must pay tax on all profit, whether you distribute it or not.
The IRS will not distinguish whether an owner of an SMLLC leaves the profits in the business bank account, reinvested profits into the business, or distributes the money as payment to the owner.
Because it’s a disregarded entity, the IRS only cares about how much profit the business made and will then tax those profits.
The IRS likely does this because it doesn’t want SMLLC owners to take different amounts of money out of the business each year to manipulate their taxes.
Here’s an example;
Let’s say Joe sells car parts and profits $100,000 this year after expenses.
Joe knows he’ll need $40,000 next year to buy more inventory.
However, even if he leaves $40,000 in his company account business-related expenses, he will still have to report and pay taxes on the full $100,000.
This is why having a good accountant on your side who can help you with your tax planning, bookkeeping, and tax preparation are so important.
Which by the way, we are back in full operation for this tax season, so if you or someone you know needs help with their business taxes, then contact us to speak with someone from our team.
2. Self-employment Taxes
The other tax for SMLLC is self-employment taxes, which is a tax that all active business owners will need to pay.
The 2021 self-employment tax rate is 15.3%.
That rate is the sum of 12.4% for Social Security and 2.9% for Medicare.
Self-employment tax applies to net earnings — what many calls profit. You may need to pay self-employment taxes throughout the year.
Now generally, 92.35% of your net earnings from self-employment are subject to self-employment tax.
Once you’ve determined how much of your net earnings from self-employment are subject to tax, apply the 15.3% tax rate.
And that should give your taxes owed.
However, for 2020, only the first $137,700 of earnings was subject to the Social Security portion of self-employment tax. In 2021, that rose to $142,800.
Single Member Tax ID Numbers
As a sole owner of an LLC, you will want an employer ID number, even if the business has no employees.
Most banks require an employer ID number, also known as an EIN, to open a business bank account.
Other clients or vendors may also require your EIN to report their income or expenses from your company.
Getting your EIN is easy. All you need to do is go to IRS website, complete an online application and you will be emailed your EIN.
So there you have it! We went over what you need to know about single member LLC in 2021.
Disclaimer: This post is for informational purposes only and should not be construed as advice. You should consult with an attorney before taking any action based on the above information.
But if it is a tax consultant you’re looking for, we’ve got you covered. Get in touch with us today!