How Much (or Little) Can an LLC Member Own?

There is a lot of talk about the danger of Single Member LLCs (SMLLCs). People have heard all kinds of stories about how they aren’t protected, the owners are found personally liable, and so on. So – are they, or aren’t they, a reasonable choice for business owners?

Personally, I think that there is still a time and a place for a single owner LLC. The cases where the owner’s protection was stripped away usually involved some kind of extra mitigating factor. For example, in one case, the owner had declared personal bankruptcy, and was trying to preserve assets in an LLC from the bankruptcy trustee. The court in that case found that there was no-one to protect, other than the owner, and that as a question of public policy, this was a tough call. Think about it: if you could eliminate your debts through a bankruptcy while keeping all of your stuff … who would ever pay for anything again? Credit would dry up overnight. In another case, this time in Florida, the owners were trying to preserve money they had received through a fraudulent credit card scheme. Again, public policy was a factor – bad guys don’t get to keep their ill-gotten loot. And yet another case I saw involved money owed to the IRS. The IRS is a federal organization, not a state organization. It’s not bound by state laws, and is often referred to as a “super creditor”, which means it has more rights than banks, credit card companies, and so on. So I’m not sure that you should never use a SMLLC – just be aware that there are times when it could be a problem.

That’s SMLLCs from a legal perspective. But there’s a tax consideration here, too. We know that Schedule C businesses are audited at about a 1 in 3 rate, whereas incorporated business structures like corporations and S corporations are audited at about a 1 in 100 rate. So incorporating is one way to lower your audit risk. However, not all businesses are suited to corporation and S corporation taxation. Holding passive real estate, for example, is designed for a passive tax structure. Or, even with a Schedule C, you may not want to be taxed as a corporation yet and have to deal with payroll. What do you do in that case?

To lower your audit risk in that instance, you might want to look at adding someone else to the company. That immediately changes your company to a partnership, filing a Partnership return. You get a Schedule K-1 to report on your tax return, not a Schedule E.

A lot of people like this method, but the next question is: What if I’m the only owner? I don’t want a partner! What do I do?

Well … you don’t have to give someone a huge interest. You can give someone a 1% or 2% ownership of your business. That’s enough to trigger the switch from 1-owner, SMLLC report on your personal return, to a 2-owner partnership, reporting on IRS Form 1065. You can make a side deal with this person to deal with any income or taxes on income that are attributable to them, so that everyone benefits. Talk with your advisor about how best to plan for this and document things carefully.

There are many variables when you’re structuring a business. That’s why it’s hard to go through a quick-service website. Unless you talk to someone who’s got some knowledge and experience on both the tax and the legal side, it’s hard to know what you don’t know. And that can leave you vulnerable.

Got questions? Contact us! We’re here for you.

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