Estate Planner May-Jun 2001
Trusts are traditionally used to protect assets. Lately, family limited partnerships and 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
On Jan. 1, 1997, the federal government issued tax classification rules 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 are generally 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 people 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, limitations and restrictions on planning don’t exist with an LLC membership interest. 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 suffer greater liability.
Charging orders. Generally, LLC statutes allow judgment creditors of LLC members to obtain charging orders against only the members. Under a charging order, if the LLC distributes profits, the debtor members’ allocable shares 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 a corporation’s owners is unquestionable in all U.S. jurisdictions. By contrast, in some jurisdictions, the member’s limited liability in 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
- 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 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. Its unique combination of legal and tax advantages often outweighs the advantages of operating in the corporate form.
Let us know if you have any questions about this or other ways to protect your assets and achieve your financial goals. We would be pleased to assist you in determining which entity is best for you.