FAQs on the SMLLC - Part 1
By Nathan Camp
As more and more Pastors and Ministry Leaders engage in the benefits of starting a Single Member Limited Liability Company (SMLLC) for their church or ministry, there is a rise in questions and a need for empowering knowledge around the subject. Here is part 1 of 2 blogs on the most frequently asked questions about the SMLLC.
Frequently Asked Questions - Part 1
1. What is a Single Member Limited Liability Company (SMLLC)?
An SMLLC is a type of limited liability company (LLC) with only one member (owner). It offers the same liability protection as a traditional LLC, shielding the church’s/organization’s assets from the company's liabilities and debts.
2. If a church wants to form an SMLLC, should they review their current bylaws to make sure they are allowed to form an SMLLC?
While it is optional for a church to review its current bylaws prior to forming a Single Member Limited Liability Company (SMLLC), It is considered a best practice to review the bylaws to ensure that there are no provisions or restrictions that might prevent the church from forming an SMLLC.
Churches generally include a statement in their bylaws or articles of incorporation that outlines their purpose, which often contains a catch-all phrase in either its articles of incorporation and/or bylaws that have language similar to the following:
to engage in activities that are necessary, suitable, or convenient for the accomplishment of that purpose and are incidental thereto or connected therewith, which are consistent with Section 501(c)(3) of the Internal Revenue Code.
3. Why should a church consider forming an SMLLC?
A church may form an SMLLC to protect its assets from potential liabilities arising from specific activities, programs, or business ventures. The SMLLC can serve as a legal barrier between the church's assets and the liabilities of the SMLLC.
For example, Church XYZ operates a daycare center as part of its community outreach programs. The daycare center provides essential childcare services to the community, but it also exposes the church to potential liabilities, such as accidents, injuries, or property damage. By forming an SMLLC to manage and operate the daycare center, Church XYZ can create a legal barrier between the church's assets and the liabilities associated with the daycare center. In the event of a lawsuit or financial claim related to the daycare center, the SMLLC would be held responsible, protecting the church's assets from being targeted to satisfy the claim.
Here is an other example, Church XYZ is planning to purchase a building to use for their worship services. To protect their assets and minimize potential liabilities associated with owning the property, Church XYZ decides to form an SMLLC. By forming an SMLLC to hold the title to the building, Church XYZ creates a legal barrier between the church's assets and any potential liabilities that may arise from incidents, accidents, or claims related to the property.
This helps ensure that, in the event of a lawsuit or financial claim involving the property, the SMLLC would be held responsible, and the church's assets would be protected from being targeted to satisfy the claim.
4. How does an SMLLC provide liability protection?
An SMLLC is a separate legal entity from its owner. This separation means that the SMLLC's debts and liabilities are distinct from the church's assets, protecting the church from financial and legal risks associated with the SMLLC's activities. Even though the SMLLC is a separate entity from its owner, it is treated by the IRS as automatically disregarded for tax purposes and has the same 501(c)(3) status as the church, allowing it to maintain the same tax-exempt status while providing an added layer of liability protection. In Martin v. Freeman, 272 P.3d 1182 (Colo. App. 2012), the Colorado Court of Appeals upheld the limited liability protection of an SMLLC Owned by Freeman. The plaintiff, Martin sought to pierce the corporate veil and hold Freeman personally liable for the LLC's actions. The court held that Freeman and his LLC were separate legal entities and maintained the limited liability protection of the LLC, preventing the plaintiff from holding Freeman personally liable for the LLC's actions.
5. What if the church (member) files for bankruptcy? Will the assets of the SMLLC be protected from the creditors of the church (member)?
While SMLLCs are effective in mitigating liabilities associated with the church's risky activities, they may not provide protection when the church faces severe financial difficulties resulting from either poor management or circumstances beyond its control.
In re Albright, 291 B.R. 538 (Bankr. D. Colo. 2003), the sole member of an LLC filed for Chapter 7 bankruptcy. The court ruled that because the debtor was the sole member of the LLC, there were no non-debtor members to protect, and thus, the bankruptcy estate included the debtor's membership interest in the LLC. The court also determined that the debtor's membership interest in the LLC gave the bankruptcy trustee the right to exercise control over the LLC's assets.
In re Modanlo, 412 B.R. 715 (Bankr. D. Md. 2006) ,the debtor was the sole member of multiple LLCs and filed for Chapter 11 bankruptcy. The court ruled that the membership interests in the LLCs were part of the debtor's bankruptcy estate, and the trustee had the ability to exercise control over the LLCs. The court cited In re Albright as a persuasive precedent in its decision. The court reasoned that since there were no non-debtor members to protect, the operating agreements of the LLCs were effectively unenforceable in preventing the trustee from taking control. Again, it is important to remember that bankruptcy cases are fact-specific, and the outcome can vary depending on the jurisdiction and the specific circumstances of the case.
While this case serves as an example of how an LLC's assets might not be protected in a sole member's bankruptcy, it is important to recognize that bankruptcy cases can be fact-specific, and the outcome may vary depending on the jurisdiction and the specific circumstances of the case. Consult with a bankruptcy attorney for the most accurate and up-to-date information regarding this topic.
6. Can a church maintain its tax-exempt status when forming an SMLLC?
Yes, a church maintains its tax-exempt status when forming an SMLLC, provided that the SMLLC's activities are in line with the church's religious, educational, and charitable purposes and are consistent with Section 501(c)(3) of the Internal Revenue Code.
When a church forms an SMLLC, the IRS treats the SMLLC as a disregarded entity for tax purposes, which means that the SMLLC's activities are considered to be the activities of the parent organization (the church) for tax purposes. As a result, the SMLLC shares the church's tax-exempt status.
However, to maintain this tax-exempt status, it is crucial that the SMLLC operates exclusively for the church's exempt purposes, as specified in Section 501(c)(3). This means that the SMLLC must not engage in activities that primarily serve private interests or generate unrelated business income, which could jeopardize the church's tax-exempt status. Furthermore, the church must ensure proper governance and oversight of the SMLLC to maintain a clear separation between the church and the SMLLC, while also ensuring that the SMLLC operates in accordance with the church's exempt purposes.
7. How do we form an SMLLC?
To form an SMLLC, the church must file Articles of Organization with the appropriate state agency, typically the Secretary of State's office. The church will also need to create an Operating Agreement outlining the SMLLC's management and governance structure.
8. What is an Operating Agreement, and why is it important?
An Operating Agreement is a legal document that outlines the SMLLC's management structure, governance, and operational procedures. It can be analogous or similar to a church's bylaws in that it creates the rules and procedures on how the SMLLC will be managed. The Operating Agreement is essential because it clarifies the SMLLC's purpose, roles, and responsibilities, helping to prevent disputes and misunderstandings. By establishing a clear framework for the SMLLC's operations, it ensures that the SMLLC is managed in a manner that aligns with the church's tax-exempt purposes and maintains a proper separation between the church and the SMLLC.
9. What are the government costs of forming and maintaining an SMLLC?
The costs of forming an SMLLC vary by state, typically including filing fees for the Articles of Organization and any annual reporting fees. Additional costs may include StartCHURCH clerical services for drafting the Articles of Organization, Operating Agreement, and applying for the Federal Tax ID number, more appropriately known as the Employer Identification Number and drafting resolutions.
10. How do we ensure the SMLLC remains compliant with state and federal regulations?
To maintain compliance, the SMLLC must adhere to any applicable state reporting requirements such as the annual report, file necessary returns such as 990 tax returns if the SMLLC is owned by an organization other than a church. Lastly, it must ensure that its activities align with the church's tax-exempt status under Section 501(c)(3).
SMLLCs can offer significant benefits to churches and ministries that have 501(c)(3) approval by providing limited liability protection, simplified administration, and flexibility in management. These advantages can support the efficient operation and growth of churches and ministries and help them achieve their mission and objectives.
* Currently, our SMLLC Program is only available in CO, GA, TX, and FL.