Single-member LLC can be good choice of business entity

June 13, 2008

Most entrepreneurs and real estate developers/investors now acknowledge that the limited liability company (LLC) has become the entity of choice for many business and investment purposes.

The single-member LLC offers a creative and efficient solution in many situations and should be considered in any “choice of business entity” debate.

Offering the dual advantages of limited liability protection (like a corporation) and pass-through tax treatment (like a partnership), LLCs seem to combine the best attributes of both corporations and partnerships.

An even more recent phenomenon is the emergence of the single-member LLC. This article will highlight some of the advantages and potential disadvantages of this developing area of law in Virginia.

Virginia amended its LLC statute several years ago to permit the formation of single-member LLCs. A single-member LLC is exactly what its name implies - an LLC with only one owner. The same degree of limited liability protection exists, but for federal income tax purposes, single-member LLCs are treated differently.

While LLCs with multiple owners typically are treated as partnerships for tax purposes, a single-member LLC is treated as a disregarded entity (i.e., a tax “nothing”). In other words, the activities of a single-member LLC are treated, for tax purposes, as if they were actually performed by its owner.

The use of single-member LLCs to hold individual real estate properties (as opposed to multiple properties being titled in the name of one entity or individual) has become increasingly common to limit liability risk, facilitate lender requirements concerning so-called “bankruptcy-remote” special purpose entity standards, and also to facilitate tax-deferred, like-kind exchanges under Section 1031 of the Internal Revenue Code.

It is also becoming more common for corporations or partnerships, for example, to form single-member LLCs as subsidiaries for the purpose of isolating or compartmentalizing business activities and assets while at the same time eliminating the need to file consolidated federal income tax returns.

Advantages

Other advantages of single-member LLCs include:

Simplicity and flexibility. LLCs are simple to form under Virginia law, annual fees are nominal, and the corporate documentation can be kept to a minimum. The LLC statute provides a great deal of flexibility concerning the management, control, and operation of company affairs.

No separate tax returns. A single-member LLC is not required to file a separate tax return for federal income tax purposes. All income, losses, and deductions are reported on the sole owner’s tax return.

Smooth transitions. The Virginia LLC statute provides relatively simple procedures for an existing entity (e.g., a partnership) to convert into an LLC. Under Virginia law, the conversion of a partnership or a sole proprietorship to an LLC is not subject to transfer or recording taxes so long as the ownership structure remains unchanged after the conversion. Thus, it is not too late for existing businesses to take advantage of the benefits offered by the LLC structure.

Disadvantages

The single-member LLC will not always be the optimal choice of entity, however, and each situation must be carefully analyzed based on its own facts and circumstances. Some factors weighing against LLCs in the “choice of entity” analysis include:

Self-employment tax issues. With some exceptions, an individual sole owner of a single-member LLC will be responsible for paying self-employment tax on all net income of the LLC. In contrast, the sole shareholder of an “S” corporation is permitted to bifurcate the income generated from the business into salary, which is subject to the self-employment tax and dividends. The self-employment tax is not applicable to this salary.

Lack of developed body of case law. Because the Virginia LLC statute is only 17 years old, relatively little case law interpreting and applying the LLC statute exists, while most issues of corporate law and partnership law have been tried and tested in the courts through the years.

Eric C. Perkins is a principal at the Richmond office of Hirschler Fleischer, where he specializes in real estate securities matters, franchising and tax-exempt organizations

Written by Eric C. Perkins  |  Filed Under Office Practices 

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