There is increasing interest in the Single Member Limited Liability Company (SMLLC) as an alternative to the sole proprietorship for the organization and operation of a small business in Minnesota. A SMLLC is an LLC in which a single individual or other entity (called a “member”) owns all of the LLC ownership interest. A SMLLC is a legal entity separate from its owner and so offers the owner a degree of protection from liability for the acts, debts, and obligations of the SMLLC.
The SMLLC also offers the choice of taxation as a corporation or taxation as a “disregarded entity” where the SMLLC is disregarded for income tax purposes and all income flows directly to the owner who reports the income and pays the tax using the owner’s personal income tax return. Anecdotal evidence would indicate that the majority of individuals considering the SMLLC as an alternative to a sole proprietorship choose to be taxed as a disregarded entity.1
The questions here do not address all issues associated with the choice of a SMLLC nor do they address the procedures for SMLLC formation.
How extensive is the liability protection given the owner of a SMLLC?
Unlike a sole proprietorship where the business owner and the business are one and the same, a SMLLC is an entity separate from its owner.2 Minnesota law provides that a member, governor, manager, or agent of a limited liability company is not personally liable for the acts, debts, liabilities, or obligations of the limited liability company.3
It is important to note that the owner will be liable for any personal guarantees or pledges the owner may make to any financial institutions or other lenders to guarantee a loan or other credit facility or financing made to the SMLLC.
The owner will be liable for any and all deliberate or negligent personal torts.
The owner can also be personally liable for actions (like signing a contract) where it is not clear that the owner is acting on behalf of the SMLLC. All documents of the SMLLC, to include checks, contracts, purchase orders, bids, and the like should bear the name of the business entity with LLC following the name. Likewise, those documents should be clear on their signature lines that the owner is an authorized signer and is signing on behalf of the SMLLC and not in his personal capacity.
Minnesota law also provides that the same conditions and circumstances under which creditors can “pierce the corporate veil” of a corporation to reach the assets of an owner also apply to piercing the veil of an LLC.4
Is the owner of a SMLLC an “employee” for purposes of federal employment and Social Security (FICA) taxes?
The owner of a SMLLC is self employed for purposes of employment and FICA taxes. Payments to the owner are not classed as “wages” but as “distributions.” The owner is subject to the self‐employment tax equal to the sum of both the employer and employee FICA and Medicare tax. For the year 2010 that total is 15.3 percent of the first $106,800 income and 2.9 percent of any income in excess of $106,800.5
Can the owner of a SMLLC deduct “trade or business expenses” of the SMLLC on the owner’s personal income tax return?
Treasury Regulations provide that the owner of a SMLLC is treated as a sole proprietor in this situation and may deduct trade or business expenses—including the LLC’s share of employment taxes—for activities carried on or through the SMLLC. These are reported on the owner’s Form 1040, Schedule C, E, or F (depending on the nature of the business).6 As a self‐employed taxpayer the owner may also deduct the cost of health insurance for the owner, the owner’s spouse, and the owner’s dependents.7
Does a SMLLC have to file an IRS election if it wants to be taxed as a disregarded entity?
Only a SMLLC wishing to be taxed as a corporation must file Form 8832 making the election. Treasury Regulations provide that an eligible entity (here the SMLLC) not filing an election will be “disregarded as an entity separate from its owner if it has a single owner.”8
Does a SMLLC require a federal Tax Identification Number (TIN)?
If the SMLLC has employees it will obtain its own TIN for making employment and FICA payments and filing quarterly and annual employment tax returns.9
If the SMLLC has no employees the owner may continue to use the owner’s Social Security number or to obtain a separate TIN. If the SMLLC does not have a TIN and the owner uses the owner’s Social Security number, Treasury Regulations require that the SSN be used for all federal tax purposes.10
Is the owner of a SMLLC personally liable for employment tax payments for SMLLC employees?
Not since 2009. Current regulations provide that the SMLLC itself and not the owner is the party liable for payment of employment taxes.11
How will a SMLLC be treated for State of Minnesota tax purposes?
Minnesota has adopted the federal tax treatment for LLC—including SMLLCs—formed in Minnesota.12
Can an LLC whose only owner‐members are a husband and wife be a SMLLC?
Treasury Regulations provide that an LLC whose only members are a husband and wife can be a SMLLC which the owners can elect to have taxed as a disregarded entity if—among other factors—the LLC is held as community property under state law.13 Minnesota is not a community property state.
A section of the Internal Revenue Code resulting from the Small Business and Work Opportunity Act of 2007 provides that a husband and wife owned unincorporated “qualified joint venture” can elect to not be taxed as a partnership and instead have the respective income of each spouse taxed as if it were sole proprietor income.14 The guidance for such an election on the IRS’ web site, however, states that “A business owned and operated by the spouses through a limited liability company does not qualify for the election.”
What is the difference between a sole proprietorship, limited liability company, and how do you choose which one is better for you? I’ll address those questions coming up. I’m Aaron Hall, an attorney from Minneapolis, Minnesota. You can find out more about me at aaronhall.com.
What is a limited liability company? Well, it’s a company that you file with your state, picking a name that you’ll do business under and you have limited liability. What that means is the company will be liable, but you’ll have some limits on how you’re actually personally liable. Let’s contrast that with a sole proprietorship. A sole proprietorship is when you just go out and start doing business. You may not have a different name, you’re just doing it under your own name. You have no corporation, no partnership, no LLC. You’re just out there doing work. Imagine you go mow somebody’s lawn or you say, “Hey, I’ll help you for a day with a particular consulting project.”
That would be an example of a sole proprietorship. So what’s the difference? Well, a sole proprietorship means that you are solely liable or you are personally liable for any problems. If you breach a contract, you’re liable. If you hurt somebody, you’re liable. If you do something wrong, you are personally liable. They can go after your home, your personal financial accounts. Are there any other differences? Well, from a tax standpoint, you can still deduct business expenses. So for the most part there is no difference with an LLC, with one exception. An LLC can be taxed as an S Corp if it files paperwork to do that, and that actually does provide a tax difference. But, most LLCs are just taxed the exact same as a sole proprietorship. Now I’m assuming you only have one member in your LLC, sometimes called a single-member LLC. I have a separate video if you want to learn more about multi-member LLCs or LLCs with multiple owners.
So let’s go back. The difference between an LLC and a sole proprietorship is an LLC has to be registered with the state. An LLC gives you some limited liability. Contrast that with a sole proprietorship. There’s no work involved. You just go do it. No need to register with a state, no legal fees, no filing fees, but you don’t have limited liability. Now, what is this limited liability? Let’s talk about that. Imagine that you are a server at a restaurant and you accidentally pour hot coffee on a baby and that baby sues, you would have personal liability for your own negligence and the company, the restaurant would have liability as well. Now imagine though that you own the company. Would you as an owner be liable? No, probably not. There are some exceptions out there, but as a general rule, simply by owning an LLC, which is in the restaurant business, you wouldn’t have personal liability for an employee’s negligence in pouring coffee on a baby.
But now imagine you are the owner. You’re working in the company and you’re the one that accidentally pours coffee on the baby. You then are personally liable. Why? Because you actually did the act. It was your own personal negligence. It doesn’t matter that you own the company. That’s not an issue. The company is going to be liable. Now you’re not going to be liable as an owner, but you’re going to be liable as an agent or an employee or the one actually doing the harm. So this is important because when you’re thinking about whether to do an LLC or a sole proprietorship, you have to think about to what extent does an LLC actually limit your liability? Let me give you an example. There’s a client of mine who is a consultant. The client only has one contract and has to agree to be personally liable for that contract. Besides that, the client has no other contracts and is otherwise liable for his own acts.
So is there any benefit to an LLC? No, not in these circumstances. Where you’re going to be liable for your own acts because you’re the only employee in the company and where you’re going to have personal liability for any contracts that you sign, you have to think to yourself, “Is it worth even setting up a limited liability company?” Now, as you might imagine, there are a lot of exceptions to all of this. I’ll give you one example. Lawyers are always personally liable for their own malpractice. So I know a lot of lawyers who decide, “Hey, if I don’t have any employees, why would I need an LLC or a corporation? I’m just going to operate as a sole proprietor.” Now, if you think it, though, the company is going to be setting up contracts and as long as you as an owner are not signing a personal guarantee, only your company, your LLC would be liable for those contracts.
So as you can see, there’s a lot to factor in, but to recap, a sole proprietorship is the default. That’s just when you go out and start doing business for somebody. An LLC gives you some limited liability, but you have to think about whether there’s any liability in your circumstances that are actually being limited. If you’re a very small company with no employees and you’re really not likely to be sued, an LLC may not be worthwhile. Whereas if you have employees, you’re entering into a lot of contracts, and you’re making significant money, it’s probably worth setting up that LLC.
If you have any questions, feel free to put them in the discussion section below. I’m happy to do my best to answer your questions, and you’ll also find other links and resources that might be helpful as you are trying to figure out whether an LLC or a sole proprietorship is better for your circumstances. I’m Aaron Hall. Feel free to contact me at aaronhall.com. And again, the best way to get ahold of me is in the comments below. Feel free to subscribe if you’d like to get more videos like this, helping you navigate running your own company.
1 The reasons for choosing taxation as a corporation (for example, tax treatment of business losses) are beyond the scope of this publication which is directed toward the SMLLC choosing to be taxed as a disregarded entity.
2 See Lattanzio v. COMTA, 482 F.3d 137 (2nd Cir. 2007) U.S. v. Hagerman, 545 F.3d 579 (7th Cir. 2007).
3 Minn. Stat. § 322B.303, subd. 1.
4 Minn. Stat. § 322B.303, subd. 2. The issue of creditors’ remedies is beyond the scope of this publication.
5 Treas. Reg. § 301.7701‐2(C)(iii).
6 Treas. Reg. § 301.7701‐2(C)(iii).
7 IRC § 162(l).
8 Treas. Reg. § 301.7701‐3(b).
9 Treas. Reg. § 301.7701‐2(C)(ii).
10 Treas. Reg. § 301‐6109‐1(b)(2)(1).
11 Treas. Reg. § 301‐7701‐2(C)(II).
12 Minn. Rev. Notice 98‐08.
13 Rev. Proc. 2002‐69.
14 IRC § 761(f)(1)(A).
This publication is published to offer timely, accurate, and useful information on topics of concern to small businesses in Minnesota. It is for general information purposes only. It is not legal advice and should not be relied on for resolution or evaluation of legal issues or questions. Readers are advised to consult with their private legal advisors for specific legal advice on any legal issues they may have.
Information in this publication on tax matters, both federal and state, is not tax advice and cannot be used for the purposes of avoiding federal or state tax liabilities or penalties or for the purpose of promoting, marketing or recommending any entity, investment plan or other transaction. Readers are advised to consult with their private tax advisors for specific tax advice on any tax related issues they may have.
This post has been adapted from the Minnesota Department of Employment and Economic Development’s publication, The Single Member Limited Liability Company (SMLLC) As An Alternative to the Sole Proprietorship Some Frequently Asked Questions