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Is a Single Member LLC a Sole Proprietorship?

Attorney Thomas B. Burton answers the following question: Is a Single Member LLC a Sole Proprietorship?

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"Is a single member LLC a sole proprietorship?"

Hello, I'm Attorney Thomas Burton and that's the question on today's episode.

So you may have heard the difference about a sole proprietorship versus an LLC and just to be clear, an LLC is a limited liability company and it's a type of entity you can form under state law in your state. I am licensed here in Wisconsin, so I will be discussing LLC's under Wisconsin law.

So a limited liability company can be similar to a sole proprietorship in that you can have what we call a single member LLC and a single member LLC can be entirely owned by one individual and where this may get confusing is the IRS will sometimes refer to a single member LLC as being taxed like a sole proprietorship.

So this question, is a single member LLC a sole proprietorship, the answer is no, it is not a sole proprietorship because in a sole proprietorship, you have no distinct business entity, meaning you have no separation from the business liability and assets.

So if you operate as a sole proprietorship and you do something for someone as part of your business and they later sue you, you have no protection from your personal assets.

Let's say your house being taken in the lawsuit. If you operate as an LLC and you maintain it properly, you're putting a corporate entity structure around your business and they could go after the assets of your business and your business insurance but not your personal assets. So a big reason to consider operating as a corporate entity is that limitation of liability, limiting the liability to the business itself and not exposing yourself to unlimited personal liability.

But whether a single member LLC is a sole proprietorship, the answer is no. The place where they are similar is on the tax side. They both have what's called 'Flow Through Taxation', by default. So unless you opt out of this as a single member LLC, you by default the income and losses from the business flow through to your individual tax return and that's where it becomes very similar to a sole proprietorship.

So if you're dealing with tax paperwork and they ask you something like are you, tax like a sole proprietorship, what they're really getting at is are you a disregarded entity what they call meaning disregarded from the owner and does the profit and loss flow through to you, the individual owner and if you are the default as a single member LLC, the answer would be yes and many single member LLC owners choose to be taxed this way because they don't want to get taxed twice on the income. By contrast, we have corporate level taxation like Walmart for example. They are taxed as a C corporation, that means the business income and losses are taxed at the entity level. Then they issue dividends to the shareholders and then the shareholders pay a tax on the dividends they receive.

So if you're the owner of your own business, you sometimes choose this form but not often because many people don't want to pay that double tax on the income. Now if you're setting up a tech startup and planning to go public and issue shares, you may be a C corporation but I'm talking about a small business like a lawn care business, is often not going to want to pay corporate level tax and then issue a dividend and pay the tax again when they receive the dividend. Instead, they're often going to opt for flow through taxation which would be similar to a sole proprietorship.

So again, is a single member LLC a sole proprietorship - no it is not. It is a separate legal entity but the similarity would be that a sole proprietorship by definition is owned by one person and a single member LLC by definition would be owned by one person. So they're still owned entirely by one individual and they have flow through taxation but as legal entities, they are separate and definitely in my opinion, you want to consider a single member LLC in order to protect yourself from that unlimited liability of a sole proprietorship.

So great question and thank you for asking. Thank you for tuning in.

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Thanks for watching and we'll see you next time.

© 2023 Burton Law LLC. All Rights Reserved. Transcript and captions provided for ease of access for the hearing impaired. For questions about this topic, or to suggest a topic for a future blog post, please contact the office.

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