The single-member LLC, examined
A disregarded entity on the tax side and a liability shield on the state side, until one of those words breaks
Contents 4 sections
single-member LLC is the default American small-business vehicle in 2016 because it is cheap, invisible to the IRS, and opaque to creditors up to the point it isn't. Most people forming one this spring will never need to think about any of those qualifiers. A meaningful minority will, and the failure modes are consistent enough to name in advance.
This is a piece for the founder who has already decided the sole proprietorship is not enough and is now choosing between forms.
When this form is the right call
Pick a single-member LLC when the business has one human behind it, at least one vendor or customer who could plausibly sue, and no near-term plan to raise outside money. That is the clean case. A consultant with recurring engagements, a landlord with one or two rentals, a designer with clients large enough to have legal departments, a small e-commerce operation with inventory and a warehouse lease — all of them belong in a single-member LLC rather than on a Schedule C attached to a personal return.
Skip the form in two situations. The first is when there will be a co-founder in the next six months; form the multi-member LLC now rather than restructure later, because adding a member changes the entity's federal tax classification and creates a short tax year nobody wants to file around. The second is when the business expects institutional equity. Venture investors will ask for a Delaware C-corp, and converting an LLC to a C-corp is not free — it is a taxable event structured as a contribution, a merger, or a statutory conversion, and each route has footnotes. Starting in the wrong form to save $300 now is a common and expensive error.
Everything else is a judgment call between a single-member LLC and nothing. Nothing is usually cheaper. The LLC is usually worth it.
Formation mechanics
The filing itself is unremarkable. You pick a state — most often your home state, occasionally Delaware or Wyoming for reasons discussed in the formation literature — and file articles of organization with the Secretary of State or equivalent. The document is short, typically a name, a registered agent, a principal address, and a signature. Fees range from $50 in the cheap jurisdictions to a few hundred in the expensive ones. Turnaround is same-day to a few weeks depending on state backlog and whether you pay for expedite.
Then there is the EIN, which you get from the IRS on Form SS-4 in one sitting. A single-member LLC is allowed to use the owner's Social Security number for tax filings, but it should not. Getting an EIN costs nothing, keeps the SSN off vendor W-9s, and is the bare minimum of operational hygiene.
The operating agreement is where single-member formations most often cut corners, and where the cost of cutting shows up years later. Most states do not require a single-member LLC to have an operating agreement. Every single-member LLC should have one anyway. It does not need to be long. It needs to state that the LLC is a separate legal person, that the member has contributed specific capital, that distributions require documentation, and that the LLC will maintain its own books. That document is one of the items a plaintiff's lawyer will ask for in discovery before arguing the entity is a sham.
Finally, open a bank account in the LLC's name using the EIN, and run every business dollar through it. Do this before the first invoice, not after the tenth.
Tax treatment in 2016
By default, the IRS treats a single-member LLC as a disregarded entity. The LLC files nothing federally. The member reports business income on Schedule C (if the business is active), Schedule E (if it is rental real estate), or Schedule F (if it is farming), exactly as a sole proprietor would. Self-employment tax applies to Schedule C income at the usual 15.3% on the first roughly $118,500 of 2016 wages and self-employment earnings combined, and 2.9% thereafter, with the additional 0.9% Medicare surtax kicking in at higher incomes under the Affordable Care Act.
Adding a second member flips the default to partnership taxation. The LLC becomes a separate filer on Form 1065 with K-1s to each member. This is rarely what a founder wants mid-year and is a good reason to decide on co-ownership before formation rather than after.
The elective paths are S-corp and C-corp. An S-corp election, made on Form 2553, lets the owner split compensation between a reasonable W-2 salary (subject to payroll tax) and distributions (not subject to self-employment tax). The savings can be meaningful — several thousand dollars a year at mid-five-figure profit, more above that — but the election brings payroll filings, a real salary, and IRS scrutiny of what "reasonable" means. It is usually premature below about $40,000 to $50,000 in net profit and routinely worthwhile above $80,000 or so. Those are rules of thumb, not thresholds; the right line depends on state payroll tax, health-insurance treatment, and retirement contributions, and is a conversation with a CPA rather than a blog.
A C-corp election is almost never right for a single-member operating business. The double tax on distributed earnings is real, the 21-percent-ish talk circulating this cycle is speculation about what might happen after November's election rather than law, and the 2016 federal rate schedule tops out at 35%. If you are planning around a C-corp, form one directly rather than elect into one.
Where this form fails
The phrase lawyers use is "piercing the corporate veil," and courts have been clear for at least a decade that single-member LLCs are more vulnerable to it than multi-member LLCs or corporations. The reasoning is mechanical: with one member, there is no one to negotiate against, no minority interest to protect, no bargained-for operating agreement, and no reason for courts to treat the entity as structurally distinct from the person behind it. Several state courts have reached that result explicitly; a few have gone further and applied reverse veil piercing to let a member's personal creditors reach LLC assets. The case law is not uniform, but the direction is.
The practical corollary is that veil protection in a single-member LLC depends on behavior, not on filings. Commingling personal and business funds is the fastest route to piercing. Paying personal expenses from the LLC account, moving money back and forth without documentation, signing contracts as yourself rather than as a manager of the LLC, skipping the operating agreement, letting the state administratively dissolve the entity for a missed annual report — each of those is a thread a plaintiff will pull. Any one of them can be survivable. Three or four together, in front of the wrong judge, are not.
The other failure mode is charging-order protection, which varies by state and is weaker for single-member LLCs in most of them. A charging order entitles a member's personal creditor to distributions from the LLC but, in theory, not to management rights or a forced liquidation. Delaware, Wyoming, and Nevada treat the charging order as the exclusive remedy in both single and multi-member contexts; most other states are more forgiving to creditors when there is only one member, on the same reasoning the veil cases use. Asset-protection planning that assumes strong charging-order protection in a home-state single-member LLC is usually planning on a bad read of the statute.
If the business is worth insuring, insure it. The liability policy is doing more work than the entity in most small-business fact patterns, and the two together are doing more work than either alone. The single-member LLC is a fine default. It is not a moat.