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LLCs aren’t required to have an operating agreement under federal and state laws. Nonetheless, drafting one comes highly recommended, especially for single-member LLCs.
An operating agreement defines who owns your business and how it should be run. With this essential piece of LLC documentation, you can handle and resolve any operational issues well. Plus, having it benefits a single-member LLC in other ways.
Key Takeaways
- Banks may require a copy of a single-member LLC’s operating agreement to allow it to open a bank account.
- You may also need to provide lenders with this document. Meeting the requirement can increase your chances of approval for business loans.
- Operating agreements are also necessary for tax classification elections and business expense deductions.
- Single-member LLCs need operating agreements to reduce its owner’s liability for their legal obligations.
- The other benefits of having an operating agreement include defining a single-member LLC’s management structure and ensuring its compliance with current legal requirements.
Opening a Business Bank Account
An operating agreement for a single-member LLC becomes important once it decides to open a business bank account. Your chosen bank may ask you to submit your LLC’s formation documents, including its operating agreement. By doing so, it can determine whether your venture is legitimate and to process its application.
Moreover, the operating agreement states that you’re authorized to:
- Make financial decisions for your LLC
- Open business bank accounts
- Transact with financial institutions, vendors, and customers.
Are Operating Agreements Required for Credit & Loan Applications?
Like banks, lenders may ask you for a copy of your LLC’s operating agreement. It’s done to help these financial institutions assess the potential risk of your business and know whether it’s legitimate or not.
A comprehensive operating agreement supports your loan application by proving that your single-member LLC conducts business properly. As a result, it can improve your chances of approval and help you secure better interest rates.
Managing Your LLC’s Taxes
Single-member LLCs also need operating agreements to manage their taxes. Particularly, these documents are important for tax elections and business expense deductions.
Filing Tax Elections
Single-member LLCs are taxed as sole proprietorships (“disregarded entities”) by default. But if you choose to change this classification, you can document the election in your operating agreement.
Here’s a quick look at the tax classifications that a single-member LLC can have.
Tax Classification | Self-Employment Tax | Income Tax Treatment |
The LLC owner is subject to self-employment tax on all net earnings. | The LLC’s profits and losses are reported on its owner’s personal tax return. | |
S corporation status | Self-employment tax is imposed on the owner’s salary. | Distributions to shareholders aren’t subject to SE tax. |
C corporation status | No self-employment tax |
|
Deducting Business Expenses
A single-member LLC can also outline rules for deducting business expenses in its operating agreement. This ensures that the venture reports all deductions properly, making it less likely to go through an IRS audit.
Related Resource
Learn how to file business taxes for an LLC (according to its classification) from NCH.
Reducing Personal Liability
Liability protection makes LLCs a great option for opening small businesses. However, it can be reduced in some cases. You can avoid personal liability for a single-member LLC’s legal obligations by following the terms of its operating agreement.
Keeping Your LLC’s Corporate Veil Intact
If a legal court finds that a single-member LLC has failed to follow corporate formalities, it may hold the owner personally liable.
An operating agreement with clear provisions about your LLC’s operations prevents such a scenario from happening. Moreover, it shows your commitment to run the LLC as a separate legal entity.
Shielding Personal Assets from Creditors
You can also include provisions related to asset protection in a single-member LLC’s operating agreement. They may cover:
- Restrictions on transferring your stake in the business
- Your LLC’s process for notifying creditors
- Specific procedures for handling legal challenges from creditors
Documenting Major Business Decisions
Single-member LLC owners should document major business decisions for strong legal protection. An operating agreement can require you to take this step and outline how to maintain important documents such as state filings and financial statements.
Defining How the LLC is Managed
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Even solo business structures need an operating agreement with clear operational guidelines. As we’ve mentioned earlier, the document outlines how single-member LLCs should be run and how its owners make informed decisions.
Your operating agreement should describe your role as a managing member, your decision-making authority, and procedures for handling operational issues clearly. It’s especially important if you decide to add members to your LLC later on.
Furthermore, a well-drafted operating agreement makes it easier to bring in potential investors. The document sets membership interests, profit distributions, and establishes management responsibilities that can be changed as your business grows.
Maintaining Compliance & Credibility
Operating agreements help single-member LLCs build trust with customers, vendors, partners, and investors as well. They’re the key to strong business relationships throughout an LLC’s lifetime.
Many vendors and business partners will request copies of your LLC’s operating agreement to verify its legitimacy and understand its business structure. Providing the documents to your future partners improves your venture’s credibility and leads to successful negotiations.
Most importantly, an operating agreement helps a single-member LLC stay compliant with federal, state, and industry regulations. Its provisions should be based on these legal requirements and guidelines.
Frequently Asked Questions
Are single-member LLCs legally required to have operating agreements?
No, single-member LLCs aren’t legally required to have operating agreements. Still, they’re recommended to create one. Having an operating agreement offers significant benefits that outweigh the minimal cost and effort needed to draft the document.
Can I write an operating agreement without an attorney’s help?
Yes, you can write an operating agreement without an attorney’s help. But if you want to avoid legal issues, ask a lawyer to review the first draft. Their expertise will ensure that the finalized document outlines how your LLC should be run and adheres to current legal requirements.
Related Resource: Learn how to write an LLC operating agreement here.
How much does it cost to create an LLC’s operating agreement?
The cost of creating an LLC’s operating agreement varies depending on how it’s done.
If you’re writing the document yourself, you can save on potential costs. Conversely, online services will draft operating agreements for $100 to $200. Lawyers charge varying fees for this task.
What happens if my single-member LLC doesn’t have an operating agreement?
If your single-member LLC doesn’t have an operating agreement, it follows state laws. These statutes might not meet your LLC’s needs and create issues with banking, taxes, and legal protection.
Can I amend my LLC’s operating agreement after creating it?
Yes, you can amend your LLC’s operating agreement after creating it.
For single-member LLCs, the changes would take effect immediately since they don’t need consent from others. However, these amendments should be properly documented and kept on file with other important documents.
How does an operating agreement help with tax audits?
An operating agreement helps with tax audits by:
- Supporting tax elections
- Outlining how your LLC deducts business expenses
Overall, taxation-related provisions in your operating agreement show that your LLC follows current tax rules.
Can banks request an operating agreement from a single-member LLC?
Yes, banks can request an operating agreement from a single-member LLC. The document can be used to verify the entity’s ownership, management structure, and legitimacy. If this information meets the bank’s requirements, your LLC will be allowed to open a bank account or secure lines of credit.
Can operating agreements help a single-member LLC maintain its liability protection?
Yes, operating agreements can help a single-member LLC maintain its liability protection. They show that the business operates as a separate legal entity.
Essentially, a single-member LLC’s operating agreement outlines:
- How the entity is run
- Who owns and manages the LLC
- How important decisions are made
- How disputes are handled
Should an operating agreement include succession planning provisions?
Yes, an operating agreement should include succession planning provisions. These terms specify what would happen when an LLC owner dies or becomes incapacitated. In turn, your business can avoid probate and stay operational during transition periods.
Can operating agreements be used to clarify owner compensation & distributions?
Yes, operating agreements can be used to clarify owner compensation and distributions. This way, you can keep personal and business funds separate, ensure accurate bookkeeping, and reduce confusion during tax filing or audits.
Expert Tips From NCH
- Include clauses related to banking transactions in your LLC’s operating agreement. They should state your authority to make these transactions on behalf of your business.
- Consider specifying your LLC’s chosen tax classification in the operating agreement. This information can then be reviewed for possible changes.
- Set clear rules for record-keeping and documenting major business decisions. Follow them to keep your LLC’s corporate veil intact.
- Detail your LLC’s purpose and authority for business expenses in your operating agreement. Both can support tax elections and deduction claims.
- Review and update your operating agreement as your venture undergoes significant changes. Do this if you’re relocating to a new state, changing your LLC’s business model, adding members, or attracting more investors.
Bonus Resource
Watch the video below to learn why operating agreements are important to LLCs.
Protect Your Investment with an Operating Agreement
When you create an operating agreement for a single-member LLC, you get several significant benefits. This document helps you conduct business without any issues while maintaining your LLC’s legal protection. And, more importantly, it prepares you for potential growth.
Do you need help drafting a comprehensive LLC operating agreement? NCH’s legal experts are ready to work with you.
DISCLAIMER: The above material has been prepared for informational purposes only, containing opinions of the provider and is not intended to provide, and should not be relied on for, tax, legal, or accounting advice. Please consider consulting tax, legal, and accounting advisors before engaging in any transaction.