Single Member LLC or Multiple Member LLC?

In some cases, a business owner forming a new limited liability company as a single member LLC (SMLLC) may raise a question as to whether there is a advantage or disadvantage to adding another person (perhaps a spouse of the member) simply to cause the LLC to become a multiple member LLC.

In the 1990’s as many states were enacting LLC statutes for the first time, many states did not permit SMLLCs at all. If you were in a state that did not allow the formation of LLCs with only one owner, the issue was clear: you needed to add another person in order to take advantage of this newly-available entity. Even if your state allowed the formation of SMLLCs, however, there was a question whether states that did not permit SMLLCs to be formed in their state would recognize SMLLCs formed in other states where they were permitted. Fortunately, all 50 states and the District of Columbia now permit SMLLCs, so that issue is no longer a threat.

There is some lingering concern among legal writers as to whether a member of SMLLC will be given the same protection from liability as a member of a limited liability company with multiple members. In most states, the statute seems clear, but it will take many years for case law to develop that will give some lawyers the comfort that comes from decades of case law on single shareholder corporations. In the end, it seems likely that a member of a SMLLC will have no less protection than a sole shareholder of a corporation.

There is one circumstance, however, where a multiple member LLC holds a distinct advantage over a SMLLC — protecting the assets of the LLC from the creditors of the member. Generally, a creditor of a member of an LLC can only seek what is known as as charging order against the member’s membership interest in the LLC. The creditor cannot directly attach the assets of the LLC but may only receive payments out of the member’s distributional interest. However, there is a question as to whether a single-member limited liability company will be effective for protection against a creditor of the sole member.

In a Colorado bankruptcy case, a debtor who filed a Chapter 13 petition that was later converted to the Chapter 7 liquidation was the sole member and manager of a Colorado LLC at the time of the bankruptcy filing. The LLC was not a debtor in bankruptcy. The Chapter 7 trustee argued that because the debtor was the sole member and manager at the time the debtor filed his bankruptcy petition, the trustee now controlled the LLC and could therefore sell the real property owned by the LLC and distribute the net sales proceeds to the bankruptcy estate. The debtor argued that trustee was only entitled to a charging order. The court ruled that because there were no other members of the LLC, the entire membership interest passed to the bankruptcy estate and the trustee became a “substituted member”. The court concluded that because there were no other members of the LLC, no written unanimous approval to transfer was necessary, as would otherwise be required under Colorado law if there were other members.

Disadvantages of a Multiple Member LLC over a SMLLC

The principal disadvantage of a multiple member LLC is that it must file a partnership tax return and comply with the sometimes complex rules of partnership taxation. A SMLLC, on the other hand, is disregarded for Federal (and most state) tax purposes. The member of an SMLLC simply reports the income and expenses of the LLC on his or her own Form 1040 on Schedule C.

In addition to the complexity of partnership taxes and the need to file an extra return, in several states (Illinois is one), there are income taxes imposed on partnerships that are not imposed on individuals.

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