How Is a Multi Member LLC Taxed? (2024 Guide) Must Read

Atty. Danya Shakfeh
Published by Atty. Danya Shakfeh | Author
Last updated: March 21, 2024
Methodology
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Starting an LLC requires careful consideration of its tax status, a decision that can shape your business's financial future.

Drawing from my experience as a corporate attorney, I've witnessed firsthand how selecting the right tax classification can significantly impact a company's bottom line and operational efficiency.

In this comprehensive guide, we delve into the essentials of LLC partnership taxation, providing you with a clear roadmap to navigate the complexities of tax planning for your business.

Quick Summary

  • Multi-member LLCs can be taxed as partnerships, corporations, or as disregarded entities, with partnership taxation being the default.
  • Being taxed as a partnership offers benefits such as pass-through taxation, limited liability for members, and simplified record-keeping.
  • According to the Internal Revenue Service (IRS), approximately 70% of LLCs are taxed as pass-through entities, subjecting members to self-employment taxes on their income from the LLC.
  • Throughout the years of working in the LLC sector, I've learned that understanding and navigating the complexities of multi-member LLC taxation is crucial for leveraging tax benefits and avoiding penalties.


Multi-Member LLCs Taxation

A woman figuring out the taxation a multi member LLCs

There are three ways that multi-member LLCs can be taxed:

  1. Partnership taxation
  2. Corporation taxation
  3. The default, which is disregarded entity status

Multi-member LLCs relate to their flexibility and convenience. For example, consider a firm in which you own shares and want to establish a multi-member LLC to protect your personal assets.

A single-member LLC allows you to significantly simplify your taxes. Assume that you and another individual own a number of properties, each of which has been created as an LLC.

You might combine all of these properties into a single-member LLC owned by one multi-member LLC using this option.

By choosing this option, you would no longer have to file a tax return for each property; you would only file one return for the entire LLC. The other advantage of this option is that you can use a single EIN for all properties owned by the LLC.

Corporations, on the other hand, are separate legal entities from their owners. The company is taxed on all profits that it can't deduct as business expenses, which is known as taxable income [1].

"Tax implications for multi-member LLCs can be complex. Consulting with a tax professional is highly recommended. Understanding the pass-through taxation rules can help you choose the most tax-efficient structure for your specific LLC."

- Jon Morgan, CEO, Co-Founder & Editor-in-Chief of Venture Smarter

Partnership Taxation

The default tax status for an LLC with two or more members is partnership taxation. This means that the LLC will file an informational return (Form 1065) and each member will report their share of the LLC's income on their individual tax return (Schedule E).

The partnership return will show the amount of income that was allocated to each partner, as well as the amount of money that was distributed to them.

Benefits of Partnership Taxation

Two people agreeing on a partnership taxation
  • Pass-through taxation – This means that the LLC's income and losses are passed through to the individual members, who are then responsible for paying taxes on their share.
  • Limited liability – Members are not personally liable for the debts and obligations of the LLC.
  • Simplified record-keeping – The partnership doesn't have to keep track of its own books and records; this is the responsibility of the individual partners.

Drawbacks of Partnership Taxation

  • Self-employment taxes – Partners are responsible for paying self-employment taxes on their share of the LLC's income. This can be quite costly since they won't be paying income tax.
  • Complexity – The partnership tax return can be quite complex, especially if there are multiple members.

How are Multi-Member LLCs Taxed?

Office workers calculating numbers

There are multiple ways that a multi-member LLC can be taxed, which include:

Dividing up the profits between members.

In the case of a corporation, an LLC operating agreement typically states that a member's distributive share is proportional to his or her ownership interest in the firm. If you want to split profits and losses in a manner that is not proportional to the members' percentage interests in the company, it's known as a special allocation.

Taxes are assessed on the entire distributive share.

The IRS views each LLC member as if he or she received his or her whole distributive share at the end of the year.

This implies that each LLC member must pay taxes on his or her entire distributive share, regardless of whether the company distributes all (or any) of the funds to its members.

Even if LLC members are required to leave money in the company — for example, to buy goods or grow it — each member is responsible for income tax on his or her proportion of the earnings.

File Form 1065 with the IRS.

Although a co-owned LLC does not pay its own income taxes, it is required to submit Form 1065 with the IRS.

This form, which is identical to that of a partnership, is a reporting document that the IRS examines to ensure that LLC members are correctly documenting their partnership income.

Estimating and Paying Income Taxes

Just as in the case of a single-member LLC, the IRS expects LLC members to estimate their annual income tax liability and make income tax payments throughout the year.

This is done via Form 1040-ES, which requires each member to submit his or her best estimate of what he or she will owe for the year to figure out their income taxes.

Multi-Member LLC Federal Taxes

Partnership taxation is the default federal tax status for LLCs with two or more members for federal income tax purposes.

This means the company will file an informational return with the IRS (Form 1065) and each member will receive a Schedule K-1, which breaks down each owner's share of the LLC's profits and losses.

Multi-Member LLC State Taxes

A man planning to get a tax ID number

Just as each state has its own rules and regulations for single-member LLCs, the same is true for multi-member LLCs.

In some states, LLCs are automatically taxed as partnerships, while in others, the tax status is determined by how the LLC is organized and operated.

It's important to speak with an accountant or tax specialist in your state to determine the specific tax requirements for multi-member LLCs to pay taxes.

When it comes to LLCs with more than one member, taxes can get a bit more complicated. In most cases, the LLC will be taxed as a partnership, meaning the company will file an informational return with the IRS (Form 1065) and each member will receive a Schedule K-1.

This document breaks down each owner's share of the LLC's profits and losses, which must be reported on each owner's individual Form 1040.

However, some states may tax LLCs differently, so it's important to check with an accountant or tax specialist in your state to make sure you're compliant.

In addition, each member of a multi-member LLC is responsible for estimating and paying his or her own income tax throughout the year.

Similar Article: Multi-Member LLC vs Single-Member LLC

Other Taxes To Pay

A group of people working on something together

There are a number of different taxes that may apply to LLCs, so it's important to be aware of them all and consult with an accountant or tax specialist as needed.

By understanding the basics of LLC taxation, you can make sure your company is operating in compliance with the law.

Be aware that there are other taxes that may apply to your LLC, such as employee taxes, FICA taxes, and unemployment taxes.

LLC Employee Taxes

If you have employees, you'll need to withhold and submit payroll taxes on their behalf.

FICA Taxes

FICA taxes are a combination of Social Security and Medicare taxes, which employees and employers both pay.

Unemployment taxes are paid by employers to help fund state unemployment programs.

For more information on these and other taxes, be sure to consult with an accountant or tax specialist. By understanding the basics of LLC taxation, you can make sure your company is operating in compliance with the law.

Self Employment Taxes

When you own and operate an LLC, you're considered self-employed, therefore subjected to self-employment tax and not income tax.

This means you need to pay taxes of both employer and employee portions of Medicare and Social Security taxes, also known as Self-Employment Tax (SET).

These self-employment taxes cover Social Security and Medicare, with a combined rate of 15.3% in 2024, according to the Internal Revenue Service (IRS).

Expenses and Deductions

As a self-employed individual, you may be able to deduct certain business expenses from your taxable income. For more information, check out the IRS website on business expenses and deductions.

There are a number of different taxes that may apply to LLCs, so it's important to be aware of them all and consult with an accountant or tax specialist as needed.

FAQs

How Does the IRS Treat Multi-Member LLCs for Tax Purposes?

The IRS treats multi-member LLCs as partnerships for tax purposes. This means that the LLC's profits and losses, which must be reported on each owner's individual Form 1040, are passed through to the owners and taxed accordingly.

However, some states may tax LLCs differently, so it's important to check with an accountant or tax specialist to see how your state taxes multi-member LLCs.

Is There Any Way to Change the Way a Multi-Member LLC Is Taxed?

There is no one-size-fits-all answer to this question, as the tax treatment of a multi-member LLC will vary depending on the specific facts and circumstances involved.

However, in some cases, it may be possible to file a special election with the IRS to have the LLC taxed as a corporation.

References:

  1. https://www.irs.gov/taxtopics/tc407

About The Author

Author
Atty. Danya Shakfeh, with over ten years of experience as a corporate attorney, leads Motiva Law, offering strategic legal advice to entrepreneurs. She is skilled at transforming complex legal concepts into clear strategies, allowing clients to pursue their goals. A "Rising Star" by Super Lawyers and an alumna of Northwestern University Pritzker School of Law, Danya is distinguished in business law.
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Growth & Transition Advisor
LJ Viveros has 40 years of experience in founding and scaling businesses, including a significant sale to Logitech. He has led Market Solutions LLC since 1999, focusing on strategic transitions for global brands. A graduate of Saint Mary’s College in Communications, LJ is also a distinguished Matsushita Executive alumnus.
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