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Sole-member LLCs Are Not Protected from Liabilities

FAS CPA & Consultants

If you own a SOLE MEMBER LIMITED LIABILITY COMPANY (SMLLC), your personal creditors can foreclosure your interest in the company in case of personal default.

 

The rule, in general, is that the money or property of a Limited Liability Company (LLC) cannot be taken by creditors to pay off the personal debts of the LLC’s owners. 

 

Florida is one of the states that adopted different rules for single and multi-member LLCs. In the Olmstead case, the Florida Supreme Court determined that creditors of an LLC owner could foreclose on a debtor’s several LLC interest. Florida amended its laws in 2011 to clarify that the Olmstead ruling applied only to SMLLCs and not multi-member LLCs. 

 

Under the new rules, if other remedies such as a charging order (forcing the LLC to pay any member’s distribution directly to creditors) proves inefficient against a collection of a personal debt of an SMLLC owner, the creditor can request the court to order that the SMLLC be sold in a foreclosure sale. Whoever purchases the SMLLC acquires all the former owner’s rights and becomes the new sole owner of the SMLLC. To get a court to order this measure, the creditor must show that the SMLLC debtor-owner will not be able to pay the debt within a reasonable time. This rule was first enacted by the Florida legislature when it amended Section 608.433 of Florida Statutes in 2011 known as the “Olmstead Patch” and this same rule was incorporated in the new Florida LLC Act effective for all new LLCs as of July 1, 2014, and for all Florida, LLCs starting January 1, 2015.

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Because of this rule, SMLLCs in Florida should have at least two members if you are concerned about liability protection from personal creditors. If you have only two members, the second one must be treated as a legitimate co-owner of the LLC. If such second owner is added just on paper as a sham, the courts will probably treat the LLC as an SMCCL. To avoid this, the second member must pay fair market value for the interest acquired and treated as a real LLC member, receiving financial statements, participating in decision making and receiving his share of LLC profits. 

 

Another option is to convert the SMLLC to an S-Corporation, but this demands citizenship or legal residency. Like an SMLLC, an S-Corporation company profits are exempt from federal and state taxation, paying only income tax on the profits of the business from your personal tax return. Unlike an SMLLC, S-Corporation profits are NOT subject to self-employment tax of 15.3% in addition to income tax. 

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If you own a SOLE MEMBER LIMITED LIABILITY COMPANY (SMLLC) you are forced to pay 15.3% self-employment tax on company profits in addition to income tax.

 

For the IRS an SMLLC is a disregarded entity, meaning that the company itself has no obligation for tax reporting. Income and expenses are allocated to the owner of the SMLLC directly on his personal tax return as if (s)he were a self-employed individual. This classification triggers self-employment tax of 15.3% over the profits of the business, except for real estate profits and any other passive income business, such as interest, royalties, etc.. 

 

This self-employment tax is imposed regardless of the activity your SMLLC is involved in. Just the fact that your company is classified as a disregarded entity, such classification triggers self-employment tax on your personal tax return over the profits of the business. 

 

Without a doubt SMLLCs are risky, allowing courts to force you to sell your SMLLC interest to satisfy a personal creditor claim in case you are deemed unable to demonstrate the capacity of debt repayment. An SMLLC is also costly due to you are subject to an added self-employment tax of 15.3% on top of your income tax. 

 

Including a second member of your SMLLC is a viable solution but it has to be for real and the new member must pay for the interest acquired in you SMLLC. Converting to an S-Corporation is another viable option but this election makes less easy to sell the business compared to an SMLLC and you will need to comply with some legalities such as being a US citizen or resident, changing your bank account and paying yourself a reasonable compensation.

 

Readers should note that this article is only intended to convey general information on these issues and that FAS CPA & Consultants (FAS) in no way intends for the contents of this article to be construed as accounting, business, financial, investment, legal, tax, or other professional advice or services.  This article cannot serve as a substitute for such professional services or advice.  Any decision or action that may affect the reader’s business should not rely solely on the contents of this article, but should rather be consulted on with a qualified professional adviser. FAS shall not be responsible for any loss sustained by any person who relies on this presentation.  This article is subject to change at any time and for any reason.

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