When A Single-Member LLC Isn't And When A Multiple-Member LLC Is

Single-member LLCs ("SMLLCs") are curious and highly useful creatures. Much of that utility is based upon their ease of organization (seldom will the sole member need to engage in detailed negotiations as to the terms of the operating agreement) and the default federal tax treatment as disregarded entities. That utility can be hampered when there is a question as to whether or not the LLC is in fact an SMLLC. Careful attention, both at the time of formation and the throughout the LLC's life, as to whether or not it is in fact an SMLLC is necessary. Absent that attention, there may be surprises, and seldom are surprises welcome. These same principles find sometimes curious application in other unincorporated forms. Conversely, we find circumstances in which at least the tax code will conflate two persons into one or in some other way elect not to treat what would otherwise be a partnership other than as a partnership.

The SMLLC is largely a creation of the so-called Check-the-Box classification regulations.1 Prior to their issuance, even as certain LLC acts contemplated SMLLCs,2 their taxation was unresolved. The Check-the-Box regulations made clear the default taxation of an SMLLC, and today every LLC Act allows for the formation of SMLLCs. An SMLLC, for purposes of federal income tax classification, will be treated as a sole proprietorship, if the sole member is a natural person, and as a division, if the sole member is a corporation or other business entity, including another LLC,3 in either case a "disregarded entity."4 Of course, certain states do not, for purposes of state income and other taxation, treat the SMLLC as a disregarded entity, but rather treat it as an independent taxpayer.5 Even though a disregarded entity for purposes of federal and certain other income tax purposes, the SMLLC has, for state law purposes, a very real existence.6

When, however, do you have an SMLLC? That threshold question is rather more involved than it may seem at first blush. Actually, it can be a rather involved question, one determined by asking first for what purpose the question is being asked.7 The question needs to be divided between whether the LLC is an SMLLC for tax purposes and whether the LLC is an SMLLC for purposes of state law. The same LLC may, when viewed through these alternative lenses, be or not be an SMLLC.

The Disregarded Entity Limited Partnership

Consider a limited partnership having the minimum required one general partner and one limited partner. Beth, a natural person, is the general partner.8 Beth's wholly owned LLC, which has not checked the box to be classified as a corporation, is the limited partner. From the perspective of state law we have a valid limited partnership; Beth and her LLC are legally distinct from one another,9 and the same "person" is not the sole general and the sole limited partner.10

Alternatively, when viewed from the tax perspective, we have a disregarded entity. Obviously, Beth is a natural person and has her own tax identity. Beth's SMLLC, however, does not for income tax purposes have its own identity. Rather, Beth and the LLC are one and the same.11 In that the purported "partnership" has but one partner, it is not subject to Subchapter K, and rather is a disregarded entity.12

Does Community Property Law Apply?

Certain states13 provide for community property ownership. Under the community property regime, each spouse is deemed to hold an undivided 50-percent ownership in all marital property. As described by the IRS:

The theory underlying community property is analogous to that of a partnership. Each spouse contributes labor (and in some states, capital) for the benefit of the community, and shares equally in the profits any...