In recent years, limited liability companies (LLC’s) have enjoyed significant gains in popularity. As the business structure of choice for numerous startups, the standard LLC serves to protect corporate assets while preserving the properties of a partnership. While both partnerships and multi-member LLCs have traditionally sprung to life through the contractual efforts of two or more individuals, the desire of single business owners to endow their companies with the same protections has given rise to a new trend: the single-member LLC. Its similarity to a sole proprietorship lies in the fact that both consist of only one member. This member can be either an individual person or an entity. The entity might actually be a multi-member LLC, but because it exists on its own, no partnership exists.
A multi-member LLC, on the other hand, consists of at least two members and often even more. That makes it a partnership, and at tax time, this distinction matters. Since, by default, federal tax law treats any partnership as a regarded entity, the multi-member LLC must file a business return on Form 1058 while each of its individual members reports profits and losses individually on their Schedule K-1s.
The Single-Member LLC in California
In the majority of states, the owner of a single-member LLC does not file a business return. Instead, he reports his company’s profits and losses directly on his Schedule C. Because federal tax law treats single-member LLCs as disregarded entities, it does not require their owners to file separate returns.
In California, however, there’s more to the story than that. If your single-member LLC pays sales tax within California’s borders, the state will expect you to do more than simply report its net income or loss on your individual Schedule C. You will also need to file a business tax return, and the owner of a California single-member LLC who fails in this regard can expect to face pointed queries concerning the business’s inventory, its equipment, its offices, its employees and its basis of operation.
If your answers lead California to deduce that your single-member LLC has indeed collected sales tax within its borders, it will insist that you file a Form 568 and pay the minimum LLC tax of $800 as well as an LLC fee that can range from a low of $900 to a current high of $11,790. The actual dollar figure involved in this fee will vary depending on the amount of your company’s gross receipts. Few states will expect this of you, and California may be unique in this regard.
LLCs and the Self-Employment Tax
The way in which single- and multi-member LLCs must handle the self-employment tax stands as another major difference. The self-employment tax consists of Social Security and Medicare taxation for individuals who work for themselves. In a multi-member LLC, only those who hold managerial positions are subject to this tax. The other participants in the multi-member LLC simply pay their individual portion of the income tax on IRS Schedule K-1.
For owners of single-member LLCs, however, things are somewhat different. In any year that their companies realize a profit, these individuals will be responsible for paying self-employment taxes in addition to their income taxes. The owner of a single-member LLC will therefore bear a double burden.
LLCs and Asset Protection
If you know anything at all about LLCs, you’re already aware of the limited liability protections that come with the territory. In a multi-member LLC, these safeguards ensure that the liability of any one participant will never exceed the dollar amount of his or her investment in the company. They also shield these individuals from responsibility for any untoward actions on the part of other members that have caused the business to incur excessive debt.
In the case of the single-member LLC, however, recent court actions have reduced the extent of such asset protections. Arguably, these rulings may permit creditors to access the single-member LLC owner’s entire interest in the company, effectively eliminating what would otherwise stand as the LLC’s biggest advantage.
Further California Considerations
Unless they have opted to be taxed as corporations, both single- and multi-member LLCs that register, organize or do business in California must pay taxes to California’s Franchise Tax Board. In addition, any California LLC regardless of format is subject to the state’s $800 minimum franchise tax while those have chosen to go the corporate route must comply with the state’s rulings on corporate taxation.
Choosing the Ultimate Business Format
Anyone seeking to organize his startup in the most favorable way needs to consider all the options. Your business is as unique as the circumstances that surround it, and choosing the proper structure is vital. Fame is fleeting, and the format that enjoys the greatest current popularity may not be the best for you.
The corporate law attorneys at Odgers Law Group have helped countless California startups not only choose the business format that suits them best but also perform the many steps required to set them up. Don’t leave this important decision to chance. You want to start your business off on the right foot. Call the business attorneys at Odgers Law today at 858-869-1114 and we’ll help to ensure that it does.