The limited liability company is touted for its tax flexibility and asset protection benefits. While valid, single member limited liability companies are ripe for alter ego claims, which means the owner losses the asset protection benefit and becomes personally liable for the debts of the company.
Let’s start with the basics. What is a single member LLC? Well, the person that has an ownership interest in an LLC is called a member. This is the equivalent of a shareholder in a corporation. As the name implies, a single member LLC is a company that has only one owner. It is legally viable and protects that owner from the debts of the company, but many owners are waiving this protection because of something known as alter ego.
The asset protection provided by an LLC is based on a legal fiction. Under the law, the LLC is treated as a physical purpose independent of the member owner. As long as this separation is maintained, the debts and obligations of the LLC do not pass through to the member owner. Many single member LLCs, however, don’t maintain this separation. Instead, the companies appear to be shams. When a judge makes such a determination, the protections of the company are set aside and the member owner is exposed.
The number one problem most LLCs have is the paperwork. You have probably read that LLCs are great for small businesses because they require little paperwork. While technically true, the lack of paperwork is a dangerous problem when the LLC is attacked. A valid, running business produces paperwork. A sham company does not. There are two particular areas where this is a problem.
The first document is the Operating Agreement. Many people set up single member LLCs through cheap online services. They get a nice fake leather book, the articles of organization stamped by the secretary of state and then a bunch of forms. They don’t fill out the forms and, in many cases, the forms are not applicable to their single member entity. When the corporate book has to be produced during a lawsuit, it is a disaster. Instead of helping prove the legitimacy of the LLC, it helps the plaintiff prove the company is a sham!
The second problem area is the lack of minutes. Technically, an LLC is not required to have minutes. Let’s be clear, however. It should. Keeping minutes regarding significant business events is evidence of a legitimate, functioning business. A company that has no such minutes is evidence of a business entity that might be a scam.
If you are the member owner of or considering forming a single member LLC, it is critical that you treat it as a legitimate business. Get a valid Operating Agreement created and minutes so that you don’t run into a situation where the entity is set aside and your personal assets [home, stock, savings] are exposed.