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If you run a business with no employees other than yourself, then you’re in good company: 33.2 million small businesses are individually operated in the United States, according to the US Small Business Administration. As a team of one, a lot of key decision making will fall to you — including choosing the right structure for your business entity.
Selecting the right business structure may not be the most exciting part of being your own boss, but it is among the most important decisions you will make. It can influence everything from your taxes, to the paperwork you need to file, to the risk of your personal assets.
While a sole proprietorship is the “simplest and most common structure chosen to start a business,” according to the US Small Business Administration (SBA), you may want to consider becoming a single-member limited liability company (LLC), in part, because of the potential tax advantages.
What is a single-member LLC?
A single-member LLC is just as it sounds — a limited liability company with one owner (referred to as a member). It’s an alternative to being a sole proprietor, but with some notable differences.
One of the biggest benefits of operating as a single-member LLC is that, in most instances, it protects you from personal liability. This means that when forming an LLC, the company becomes its own legal entity and your personal assets — like your house and vehicle — won’t be at risk if your company faces lawsuits or bankruptcy.
Establishing a single-member LLC does require some legwork. Requirements vary from state to state, but this typically includes filing Articles of Organization (part of a legal document used to establish an LLC at the state level), filing any required state compliance reports like annual reports, paying filing fees (which range from around $40 to $200, depending on the state), and selecting a registered agent.
There may also be annual fees (from zero to $800+) and ongoing reporting requirements in your state, so it pays to do some research.
What’s the difference between a single-member LLC and a sole proprietorship?
One of the main reasons a sole proprietorship (also sometimes referred to as a sole-tradership) is among the easiest and most common business structures is because you don’t have to take any formal action to become a sole proprietor, like filing paperwork. For example, if you’re a freelance writer, then — presto! — you’re already a sole proprietor.
However, unlike a single-member LLC, as a sole proprietor, there’s no legal separation between you and your business. So, you can be held personally liable for the debts and obligations of the business. To put it another way, being a sole proprietor does entitle you to all company profits, but you’re also responsible for all the business’s debts, losses, and liabilities. It’s something to keep in mind as you determine the best path for your needs.
There are also some important tax consequences to consider.
Tax advantages of single-member LLC
After limiting personal liability, the flexibility in taxation is probably the second biggest benefit of forming an LLC.
Typically, a single-member LLC is taxed the same as a sole proprietorship, meaning that your LLC is considered an “entity disregarded as separate from its owner” in the eyes of the IRS. As a pass-through entity, any business tax obligations are passed on to your personal tax return through a Schedule C.
An LLC, however, can elect to be taxed as a corporation — either a C Corporation or S Corporation. This option can reduce your self-employment tax burden, because only the salary you pay yourself is subject to self-employment taxes.
As a C Corporation, profits are taxed at the corporate income tax rate, which could prove to be advantageous. There is, however, the risk of double taxation — when your company is taxed on its profit, and taxed again when dividends are paid to you on your individual tax return.
When you choose to be taxed as an S Corporation, however, you can avoid the downside of a double tax hit. Income tax gets reported on your personal income tax return without being subject to corporate tax rates. Something business owners should keep in mind is that while they will not be paying self-employment taxes on their entire profit, they’ll need to pay FICA taxes and regular income tax on their salary, if they choose to be taxed as an S corp.
There are some other benefits a single-member LLC structure brings to the table. According to SCORE, a nonprofit organization and resource partner of the SBA, generally, “LLC owners find the S corp option more attractive than the C corp because, with C corp tax treatment, profits are taxed at the corporate level, and then the distributions made to the owner are taxed on the individual level, as well.”
There are many factors to consider when determining the best tax status for your LLC; if you are trying to figure out the best fit for your needs, it can be a good idea to reach out to your accountant for their thoughts.
In terms of business structures, there can be a lot to keep track of, so we’ve included a quick overview below for reference:
|Sole proprietorship||One person||Unlimited personal liability||Personal tax only – Pass-through|
|Partnerships||Two or more people||Unlimited personal liability unless structured as a limited partnership||Self-employment tax (except for limited partners)
|Corporation – C corp||One or more people||Owners are not personally liable||Corporate tax
Owners file W2
|Corporation – S corp||One or more people, but no more than 100, and all must be U.S. citizens||Owners are not personally liable
Can’t have money in the accounts at the end of the year
Owners draws or W2s
|Limited liability company (LLC)||One or more people||Owners are not personally liable||Self-employment tax
Personal tax or corporate tax
|Corporation – Nonprofit||One or more people||Owners are not personally liable||Tax-exempt, but corporate profits can’t be distributed|
Benefit from tax deductions
As a single-member LLC filing as an S corp, you may also be able to deduct expenses that are not deductible for those filing as a C corp. While occasionally overlooked, don’t sleep on these potential savings: they can add up!
For instance, many single-member LLC owners and sole proprietors work from a home office and might not realize they’re able to deduct personal expenses such as internet, phone, or even their vehicle. Additional deductions could include promotional events held at your home (or elsewhere, such as a trade show), subscription costs for publications related to your business, and licensing fees to conduct your business.
How do I pay myself as the owner of a single-member LLC?
As a single-member LLC, you don’t get paid a salary. Instead, you withdraw money from your business account as needed, which is referred to as an “owner’s draw.”
Keep in mind that you’ll need to set aside enough money to pay your tax bill come tax season if you opt for an owner’s draw.
However, if you decide to have your LLC taxed as a corporation that changes the game a bit.
If your LLC is taxed as a corporation, you’ll be considered an employee and you may have to pay yourself through payroll. This means you must follow the same tax rules as any other employer, including withholding payroll and income taxes from your pay and filing quarterly employer tax returns.
Partnering with a payroll service provider can help ensure you remain compliant and up to speed on any legislative changes should you pay yourself through payroll.
For many, structuring the business as a single-member LLC makes sense given the potential tax benefits, not to mention the advantage of limited liability. It is important, however, to weigh all the pros and cons when determining what’s best for you.
Sure, you can always convert to a different business structure down the road, but there could be restrictions based on your location and it could result in tax consequences, among other complications. According to Section 446(e) of the Internal Revenue Code, taxpayers are required to obtain consent from the IRS before changing a method of accounting for federal income tax purposes. You also may need to re-register with the IRS, and could end up receiving a new EIN, so it’s best to get it right at the start.
In the end, turn to a trusted advisor, like your accountant, for guidance on the business structure that’s right for you.
Please note all material in this article is for educational purposes only and does not constitute tax or legal advice. You should always contact a qualified tax, legal or financial professional, in your area for comprehensive tax or legal advice.