Let’s take a dive into the need for an operating agreement for single-member LLC today.
Limited Liability Companies (LLC) are hybrid businesses that act as a sole proprietorship or partnership for tax structure, but with the limiting liability of a corporation. The owners of LLCs are called members. Limited Liability companies are actually the creation of a separate entity that can own assets and acquire debt just like a living person.
LLCs come in two varieties: single-member (one owner) and multi-member (two or more owners) and every state require LLCs to have an operating agreement in writing with the LLC records. This holds true even when the LLC is a single-member LLC. Most people see the benefits of an operating agreement with multi-member LLCs but it is necessary to have an operating agreement for single-member LLC too.
What is an Operating Agreement?
An operating agreement is basically an agreement between the members of the LLC. It is a document that outlines the who, what, when, where, why, and how of the LLC. It contains information about the owners, the structure, the rules, how things will operate, and the way to make amendments to the LLC.
If you look at an LLC like a marriage, either member to business or members to each other, the operating agreement is like a prenuptial agreement. It outlines the requirements of the parties, expectations of the parties, and how expectations of the parties not met will be handled.
While operating agreements are not filed documents, most states require them to be done at the creation of the business and kept with the LLC’s file for review at any time. Operating agreements are not notarized but must be signed by all members.
Why Its Necessary to have An Operating Agreement for Single-Member LLC
So, you may be asking, is it necessary to have an operating agreement for single member LLC? The answer is yes. Beyond the requirement of most states, here are five reasons.
The Operating Agreement Defines the Organization
The first purpose of the operating agreement is to define the LLC. The document describes the industry, the formation timing, procedures, and assets of the business. The LLC clarifies the contribution and distribution of the owner. The operating agreement for single-member LLC will define the roles and pay types the owner will receive for tax purposes.
The Operating Agreement Separates the Business and Member
As discussed above, the purpose of the LLC opposed to just a sole proprietorship is to give the owner liability protection. Having an operating agreement for single-member LLC, and keeping good LLC records of the operation, are the first steps to showing the world (especially Uncle Sam and Lady Justice) that the LLC is its own entity and protects the member’s personal assets.
It also allows the assets to not only be purchased by the LLC but is a second documentation that the assets are the business’. These assets may be totally tax-deductible expenses when owned by the business, but would only be partial to non-deductible without the separation that the operating agreement brings.
It is also necessary to separate the business in order for the business to file for its EIN tax id.
Clarifying Operations of the Business
Having an operating agreement for single-member LLC also allows the member to plan out how they will deal with issues of the business if they should arise with a clear head and not while under the stress of dealing with the issue. This also gives the member guidance too for what purpose they are setting up the LLC.
Clarifying Business Succession
One of the great things about LLCs and Corporations is they are their own entity and can “live” beyond the member’s health or actual life span. The operating agreement can define how the death or disability of a member, especially in a single-member LLC will be dealt with. Often when these situations happen, the court and state will use this as guidance for transfer purposes.
Avoiding Your State LLC Default Rules
Every state has its own rules of what must be in the operating agreement, but it also has default rules that are not required, but handle situations where the operating agreement is not specific. It is a must to research what these default rules are and make sure that if you don’t like them, you create the operating agreement for single-member LLC to specify your rules in order to override the default rules. If you do like the default rule, it is still a good idea to include them in the operating agreement as state rules can and often frequently do change.
Never Use Free Template Operating Agreements
These template operating agreements can be a good resource to get you thinking about things that you might not have thought about when drafting your operating agreement, but these templates often are not written for specific industries that require clauses not found in other industries, state rules, your needs, and many other needed parts to the operating agreement.
Being a single-member LLC, I advise you to hire an attorney who can help you draft an operating agreement that fits your situation and/or speak to an accountant to make sure you set yourself up for the most savings and liability protection.