Deciding the legal form of an enterprise is one of the first questions to be addressed by entrepreneurs.
In our last article, we compared the characteristics of Standard C Corporations, S Corporations, and Limited Liability Companies (“LLCs). In this piece,
I want to focus on comparing single member LLCs and multimember LLCs. As the chart below shows, there are some distinct differences between the two arrangements.
Over all, the problem with single member LLC startt ups is that they are prone to be managed as if the member were a sole proprietor, i.e. without attention being paid to formalities, like establishing separate bank accounts for the company, segregating company assets from the personal assets of the member, or implementing an operating agreement, which is often required under most state laws.
The lack of formalities can lead to the heightened exposure of the member’s personal assets to creditor claims.
Single Member Multi-Member
Taxes paid on individual 1040 return; no company filing is required.
LLCs treated as partnerships file a Form 1065 and issue K-1s to members; profits and losses are reported on the individual member’s tax return.
Individual member is liable for Social Security and Medicare Taxes (Self- Employment Taxes) as well as taxes on realized profits.
A single member in an LLC can also elect to have the entity treated as an S corporation and thereby be able to reduce Self Employment Taxes.
Generally, only managing members are subject to self-employment taxes for services rendered to the LLC. Non-managing members are only liable to pay taxes on their profit share.
Certain States impose additional taxes on partnerships.
A creditor of a single member LLC can only proceed against the assets of the LLC and not against the individual member’s personal assets
A creditor of a multimember LLC can only proceed against the assets of the LLC and not against the personal assets of the individual members
State law specific. Creditor of single member can proceed against member’s entire interest in LLC, including member’s assets in the LLC.
According to one source, Wyoming, Nevada and Delaware afford the same asset protection to single member LLCs as afforded multimember LLCs. On the other hand, 18 states provide that creditors of a member of a single member LLC may be able to reach company assets.
State law specific. A creditor of a member in a multimember LLC is restricted to attaching the member’s distribution interest
In New York, the law is creditor friendly in allowing creditors not only to obtain charging orders to attach a debtor-member’s distributions, but also to foreclose on the member’s ownership interest and even to seek dissolution of the company and the sale of its assets.
Insofar as single member LLCs frequently fail to document corporate formalities and may not even have an operating agreement, the individual member may be at heightened risk to have the corporate form disregarded and thereby expose personal assets to attachment.
Generally, multimember LLCs are better documented and usually have an operating agreement to help manage the multimember character of the enterprise thereby reducing liability risks.
The take away:
To maintain the legal integrity of your form of business entity requires ongoing monitoring and engagement with legal and financial professionals.
For members of single member LLCs, in particular, there is a tendency to be lulled into a false sense of security that the corporate form will hold and personal assets will be protected in the event of a legal dispute with creditors.
However, this may not always be the case depending on applicable state law and the level of formality with which the single member has managed her small business.