Changing from a single-member LLC to a multi-member LLC is a common way for business owners to expand their businesses.
The process of changing your LLC from a single member to a multi-member is not difficult, but there are some essential steps you need to take to make the change.
The Venture Smarter team engaged in an in-depth debate and research to provide you with first-hand advice from attorneys, legal advisors, and other experts in this field.
Let us walk you through the characteristics of a single-member LLC first.
What is an LLC?
An LLC is a limited liability company commonly used organizational structure for startups and small business entities. The business structure and flexible management allow for the easy establishment, as well as a tax structure of a partnership combined with the limited liability protection of an LLC .
In contrast to corporations, LLCs are under state law, and their operations differ according to the state.
What is a Single Member LLC?
A single-member LLC is a limited liability company (LLC) that is owned by a single person. This type of LLC offers the same limited liability protection as a multi-member LLC, but it is much simpler and less expensive to set up.
Since a single-member LLC is owned by a single person, it does not have a board of managers.
There is only one member, and that member has the right to make all business decisions unilaterally.
The main advantage of a single-member LLC over a multi-member LLC is its cost – it's much cheaper to operate a single-member because there's no need for additional members or officers.
The designation of a single-member LLC is made in the Articles of Organization when filing with your state, so it's hard to miss.
Other than filing fees, which vary from state to state, there isn't much difference between the cost of setting up a single-member LLC and a multi-member one.
But what happens if you change your mind and want to convert your single-member LLC into a multi-member?
Converting into a Multi-Member LLC
There are a few reasons why you might want to add a new member to your LLC and change it into a multi-member LLC.
Perhaps you've decided you need more help managing the business through partnerships, or maybe you're looking to attract new investors. However, there are a few things you must put into consideration during the converting process.
Contracts and LLC Operating Agreement
Before you can expand your LLC and add a new member, you must first amend the Articles of Organization. This is typically done through an LLC Operating Agreement or Written Consent from all existing members.
Your state may require that the LLC operating agreement be recorded with the Secretary of State before it is accepted and implemented by your LLC.
Be sure to check whether there are any specific requirements in your state for the approval of an operating agreement amendment.
Membership Transfer Rights:
The Operating Agreement should also include the details of any membership transfer rights and membership interest, including restrictions on sales to non-members.
Be sure that you follow the state law, rules, and regulations regarding how a member can sell his or her interest in the LLC.
State The Specifics of Your Expanded LLC
Once you've decided on the Operating Agreement, the next step is to file your articles of amendment with your state.
When preparing an amendment for increasing LLC members, be sure to provide accurate numbers and avoid using abbreviations in your operating agreement.
If you don't, it may cause unforeseen problems that are difficult to unravel.
The state will then go through its approval process, which can take anywhere it may delay the process or even lead to the rejection of your filing.
Be sure you understand how your state treats single-member and multi-member entities, so you know whether an Operating Agreement or a separate entity is necessary (such as a corporation, partnership, or trust).
Remember, the key to converting your single-member LLC into a multi-member is having proper legal documentation reflected in your operating agreement.
Of course, state rules and regulations may vary from those outlined here, so be sure you check with a law firm that specializes in this area if you're not sure how to proceed.
Depending on the state law in which your Limited Liability Company is registered, you may also be required to notify other agencies when expanding your membership.
For example, if you add a member who will have an ownership interest in your LLC, you'll need to file a new Form 1065 with the IRS. This is the tax return that reports the business' income, deductions, credits, and other tax items.
Tax Consequences of Adding a Member to an LLC:
As with any business decision, there are tax consequences to adding a member to your multi-member LLC.
Unlike most property exchanges, contributing funds to an LLC in exchange for member interest is not subject to tax gain or loss for the parties concerned.
That's because, for tax purposes, an LLC is considered a disregarded entity, so ownership changes do not result in federal taxes; however, when you do add a partner, you will be taxed as a partnership and must file a Schedule K-1.
This is how non-disregarded entity members will be taxed for their share of LLC net income or loss on Form 1065.
For example, a new member might cause the business to generate more taxable income or trigger state income taxes on a new non-disregarded entity. Furthermore, certain states will require a separate filing for LLCs that have multiple LLC members.
In any case, it is essential to seek legal advice from a law firm or from a tax professional before changing the makeup of your multi-member LLC.
Is It More Beneficial For a Limited Liability Company To Be a Single-Member or a Multi-Member?
Sometimes it may be beneficial to convert your LLC into a multi-member LLC or different type of business entity if:
- Do you want to find funding from venture capitalists or angel investors
- You plan to expand outside your home state
- You have employees
- Your company is growing too fast for a single-member LLC
- You are sued or want to sue someone
Converting Limited Liability Companies to a multi-member LLC can offer some liability protection if you're worried about being personally sued.
Additionally, it can issue shares of stock, which could be attractive to potential investors.
What to Consider When Deciding Between a Single Member LLC and a Multi Member LLC
When deciding between a single-member LLC and a multi-member LLC, one thing to keep in mind is that the main difference lies in the number of owners or members and the way they are taxed.
A single-member LLC is simpler because it does not require a federal tax return unless it chooses to be taxed as a corporation, and one member has full control over the company . In a multi-member LLC, a decision has to be made about what percentage of profits and losses will be shared among its members.
Also, a multi-member LLC has no limit to the number of members it can add. It has the option to be taxed as an S corp or a C corp.
Why Add New LLC Members?
Do you want to add new LLC members to your company? There are several reasons to add new LLC members:
- Acquiring a new business partner
- Requiring capital for business expansion
- Giving employees a share of ownership
Legal Support When Adding New Members to an LLC
When adding new members to the LLC, you are required to do the following:
- Add the names of the new members when to the Articles of Organization
- Add details on how the membership interests will change in the organizational agreement
- In case your company has been paying taxes as a sole proprietorship, you must close your accounting books and records when new members are acquired
- You are required to file a short-year tax return for the current year if your LLC adds a new member during the tax year
Do I need a new Employer Identification Number if I change from a single-member to a multi-member LLC?
You will need a new Employer Identification Number if you add a new member, but not if the ownership percentages stay the same in the multi-member LLC.
Can You Convert an LLC to a Partnership?
Yes, you can convert an LLC to a partnership when you add a new member, but there are consequences involved. A business partner will be taxed on their share of LLC net income or loss on Form 1065. You must also file a Schedule K-1 for each business partner.
Change From Single Member LLC To Multi-Member LLC...
To summarize, you can always add members to your limited liability company.
But if you do, be sure that it is in accordance with your state's laws regarding LLCs and that you understand the consequences and tax benefits of adding a new member.
If you are unsure of what is best for your company, it is always a good idea to consult with a tax professional.