Single member LLCs: A guide to disregarded entities for tax purposes

Ines Zemelman, EA

• 12.03.24 • 5 min read

Whether you're a budding entrepreneur, a professional looking to formalize your business, or simply curious about this business structure, this guide is designed to provide you with a clear understanding of what a single-member LLC is, how it works, and how it differs from other business entities.

Our goal is to provide you with the knowledge to make an informed decision about whether an SMLLC is the right choice for your business endeavors.

What is a single-member limited liability company?

An SMLLC is a business entity that combines the simplicity and flexibility of a sole proprietorship with the liability protection of a corporation.

As the name implies, it is formed by a single individual who owns and operates the business. This structure allows the owner to benefit from the profits of the business while being protected from personal liability in most cases.

An SMLLC is recognized as a separate legal entity from its owner, which means that the owner's assets are typically protected in the event of a lawsuit or business debt.

Distinction from other business structures

Understanding how a single-member LLC differs from other business structures is critical to determining if it's right for your business. Here are some key differences:

1. Sole proprietorship. Unlike a sole proprietorship, where the business and the owner are considered the same legal entity, an SMLLC provides a legal separation between the two.
   This separation provides liability protection, meaning that personal assets are generally not at risk in the event of business liabilities or lawsuits.
   However, in a sole proprietorship, the owner is personally liable for all business debts and obligations.
2. Partnership. A partnership is two or more individuals who own and operate a business together.
   In contrast, an SMLLC is owned solely by one individual. While partnerships require agreements that outline the roles and responsibilities of each partner, an SMLLC does not have this complexity due to its single ownership.
3. Corporations. Corporations, including C corps and S corps, are more complex in terms of tax and regulatory requirements. They offer liability protection but come with more rigid structures and formalities, such as holding annual meetings and maintaining corporate minutes.
   An SMLLC, on the other hand, offers a simpler structure with fewer formalities, making it a more flexible option for individual owners.
4. Limited liability partnership. LLPs are similar to limited liability companies in that they provide liability protection, but are typically used by professional groups (such as lawyers or accountants).
   Unlike an SMLLC, which is for single owners, LLPs require two or more partners.

One of the main advantages of an SMLLC is its tax flexibility. It is typically treated as a "disregarded entity" for tax purposes, meaning that the business itself is not taxed directly.

Instead, profits and losses are reported on the owner's tax returns. This is in contrast to corporations, which are subject to corporate tax rates and potential double taxation on dividends.

Advantages of an SMLLC

An SMLLC offers some benefits that make it an attractive option for entrepreneurs and business owners. From legal protections to tax efficiencies, the advantages of operating as an SMLLC are significant.

Here are the key benefits that set this business structure apart:

1. Liability protection
   As an SMLLC, your assets are generally shielded from business debts and legal judgments.
   This means that in the event of a lawsuit or financial loss, your assets, such as your home, car, and personal savings, are protected.
2. Tax benefits
   Typically, a disregarded entity LLC is taxed, meaning the business itself is not directly taxed.
   Instead, the profits and losses of the business are passed through to the owner's tax return, avoiding the double taxation often associated with corporations.
   In addition, SMLLC owners may qualify for certain tax deductions, such as the home office deduction, which can further reduce their taxable income.
3. Management and operational flexibility
   Unlike corporations, which must have a board of directors, hold regular meetings, and keep detailed records, SMLLCs are not bound by these formalities.
   This flexibility allows you to make decisions quickly and adapt to changing business needs without the need for extensive paperwork or formal approvals. This streamlined approach can be especially beneficial for small businesses and sole proprietors.
4. Improved credibility and name protection
   Having "LLC" in your business name can add a level of professionalism and legitimacy that can be especially beneficial when dealing with other businesses, banks, and potential customers.
   In addition, once you register your SMLLC, your business name is protected in your state. This means that no other business in the state can use the same name, providing a level of brand protection and helping to establish your unique identity in the marketplace.

How to form a single-member LLC

Forming a single-member limited liability company involves several key steps, each of which is critical to the legal and operational structure of your business.

The key steps in forming an SMLLC:

1. Choose the name of your LLC
   Choosing a name for your Single Member LLC is a critical first step in the formation process. It's not just a label for your business; it's a reflection of your brand and a key aspect of your legal identity.
2. Designate a registered agent
   The next important step is to appoint a registered agent. This role is critical to ensuring legal compliance and the smooth operation of your LLC.
3. Obtain proper licenses and permits
   The next step is to ensure that you have all the necessary licenses and permits to legally operate your business. This step is critical, as it varies greatly depending on your location and the type of business you are conducting.
4. Register your SMLLC
   After securing the necessary licenses and permits, the next critical step in forming your single-member limited liability company (SMLLC) is to officially register it with your state. This process solidifies the legal standing of your business and is essential for operational legitimacy.

How a single-member LLC Is taxed

For effective financial planning and compliance, understanding the tax implications of an SMLLC is critical.

The taxation of an SMLLC is unique and offers flexibility that can be beneficial to business owners.

Tax status of disregarded entities

A disregarded entity indicates that for tax purposes, the LLC is not viewed as distinct from its owner, negating the need for a separate return.

Consequently, the entirety of the LLC's profits and losses are documented on the owner's personal income tax returns.

This status bestows upon the SMLLC the benefit of pass-through taxation. Rather than the business incurring tax liabilities, these obligations are transferred to the owner's tax returns and subjected to their tax rates, thereby eliminating the requirement for a separate return for the business.

Filing tax return as a sole proprietor

Due to its unique tax status for federal tax purposes, an SMLLC's financial activities, including income and expenses, are directly reported on your tax returns.

Since an SMLLC is treated as a disregarded entity for federal income tax purposes, all its business income, losses, deductions, and credits must be declared on your personal income tax return.

This is usually done on Schedule C (business income or loss), which is filed with your tax return (Form 1040).

Income from your SMLLC is subject to self-employment taxes, which include Social Security and Medicare taxes. You'll need to calculate this using Schedule SE (self-employment tax) and include it on your tax return.

Options for electing corporate tax status

1. Election of S corporation status
   An SMLLC can elect to be taxed as an S corporation by filing Form 2553 with the IRS. This election can provide tax savings on self-employment taxes because the SMLLC's profits can be divided into salary and dividend distributions.

   Also read. How to change an LLC to an S corp

2. Election of C corporation status
   Alternatively, an SMLLC can elect to be taxed as a C corporation by filing Form 8832 (entity classification election). This election is less common for SMLLCs due to the potential for double taxation (the corporation pays taxes on earnings and the business owner pays taxes on dividends).

   Also read. How to change an LLC to a C corp

Electing to be taxed as a corporation can be advantageous in certain circumstances, such as when the business generates large profits or needs to retain earnings within the company.

How to hire employees as a single member LLC

Expanding your Single Member LLC to include employees involves several important steps and considerations, both from an operational and tax perspective.

Hire process and considerations:

1. Obtain an employer identification number. If you don't already have one, you'll need to obtain an EIN from the IRS for tax purposes.
2. Comply with labor laws. Make sure you understand and comply with federal and state labor laws, including minimum wage, overtime, and workplace safety regulations.
3. Employee documentation. Properly document employee information and maintain records as required by law. This includes completing the I-9 employment eligibility verification form and maintaining records of employee tax forms.
4. Payroll setup. Establish a payroll system to accurately calculate wages, and withhold taxes, and maintain records of payments.

Employment tax obligations:

1. As an employer, you are responsible for withholding federal income, Social Security, and Medicare taxes from your employee's wages.
2. You must also pay your share of Social Security and Medicare taxes, as well as the Federal Unemployment Tax (FUTA) and any applicable state unemployment taxes.
3. File regular employment tax returns with the IRS and state agencies. This includes filing Form 941 (employer's quarterly federal tax return) or Form 944 (employer's annual federal tax return) and issuing Form W-2 (wage and tax statement) to employees annually.
4. Depending on your state, you may be required to provide workers' compensation insurance for your employees, which covers medical care and compensation for lost income if they are injured on the job.
5. If you offer benefits such as health insurance or retirement plans, ensure compliance with relevant laws and regulations, including the Affordable Care Act (ACA) and ERISA.

Disclaimer: This article is for informational purposes only and does not constitute legal or tax advice. Always consult with a tax professional regarding your specific case.