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. 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, however, is the emergence of the single-member LLC and the purpose of this article is to 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 expressly 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. Whereas LLCs with multiple owners typically are treated as partnerships for tax purposes, a single-member LLC is treated for federal income tax purposes as a disregarded entity (i.e., a tax “nothing”) (although special elections can be made for different tax treatment).
The use of single-member LLCs to hold title to individual real estate assets (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.
Other advantages of single-member LLCs include:
Simplicity and Flexibility. LLCs are simple to form under Virginia law, annual fees are nominal, and the entity documentation can be kept to a minimum. Virginia’s 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. Further, 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.
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 that may weigh 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 may be able to bifurcate the income generated from the business into salary, which is subject to the self-employment tax, and dividends, which is not subject to the self-employment tax.
Lack of Developed Body of Case Law. Because the Virginia LLC statute is less than 20 years old, there is relatively little case law interpreting and applying the LLC statute, while many issues of corporate and partnership law have been tried and tested in the courts through the years.
In conclusion, the single-member LLC offers a creative and efficient solution in many situations and should be a topic of discussion and consideration in any “choice of business entity” debate.