If you are thinking about forming a business, one of the first things that you will have to decide is what type of entity it should be.
There are many different types of entities, each with its own advantages and disadvantages.
A multi-member LLC is a business entity that two or more members can form, and it's becoming increasingly popular with business owners who want to join forces when setting up their company.
How Does a Multi-Member LLC Work?
A multi-member LLC is simply a limited liability company with more than one owner. The company members are responsible for its debts and liabilities, and they share in the profits and losses of the business.
Multi-member LLCs offer several benefits over other types of business entities, including:
- Limited liability – LLC members are not personally liable for the debts and liabilities of the company.
- Tax flexibility – The members can choose how to be taxed, as a partnership or as an individual.
- Ease of formation – Multi-member LLCs can be formed in most states and don't require a lot of paperwork to get started.
- Flexibility – LLC members can agree on how the business will be run and then take their share of the profits or losses as they occur. They aren't required to keep formal records unless there is a dispute, which means that it's up to them to pay themselves a salary or take distributions from the company.
Unlike a single-member LLC that has only one member who makes all the decisions, LLC with multiple owners will need to agree on how the company will be run, and then they will need to create and file an operating agreement.
This document will outline the rights and responsibilities of each member and how profits and losses are divided among them.
The biggest advantage of a multi-member LLC is the limited personal liability it offers to its members.
This means that if an LLC goes bankrupt or gets sued, the members are not liable for any of the company's debts or liabilities.
LLC members are protected against the liabilities of other members, so if one LLC member is sued, the other members are not affected.
Multi-member LLCs are an excellent option for businesses that want to join forces and have limited liability protection.
Multi-Member LLC Taxation
By default, a single-member LLC is treated as a disregarded entity for federal income tax purposes. Multi-member LLCs are treated as partnerships.
This taxation method implies that the LLC itself does not pay any taxes and instead "passes through" its income or loss to each of its members' personal income tax returns.
This means how multi-member LLC are taxed is just as if it were a general partnership in which all of the partners equally shared in profits and losses for each fiscal year.
Multi-member LLCs pay taxes on the individual level, even if there is no partnership income. i.e., the company generates no profit. State income taxes may still apply.
The default tax classification for an LLC can be changed by filing two IRS Forms, Entity Classification Election.
This form allows a multi-member LLC to elect to be taxed, S, or C corporation. To make an S Corp tax election, LLCs have to file Form 1553 (Corporation Income Tax Return), while C corporation tax treatment can be made through Form 8832.
Corporate income is subject to double taxation, so multi-member LLC members are taxed individually.
This means that there is no corporate tax when an LLC produces a net operating loss (NOL), which could be passed through to the owners' personal returns, so they can use it in future years when income exceeds deductions and credits.
Depending on the LLC tax status and other factors, members may also be responsible for payroll taxes. Members who are employees of the LLC pay self-employment tax on their net earnings from the company.
This is a Social Security and Medicare tax that is paid at a rate of 15.30% (12.40% for social security and Medicare each). Employers also pay an unemployment insurance tax, which varies by state.
Sales tax is applied to LLCs that sell goods or services in states that impose a sales tax. The sales tax rate will depend on the state and local sales tax laws.
It is important to consult with a tax professional about taxes in your location to determine whether your multi-member LLC should be classified as a partnership or corporation.
Multi-Member LLC Management
The management structure of multi-member LLCs allows each member the ability to contribute equally in management (a member-managed LLC) or for one member to manage more frequently (manager-managed LLC).
We recommend creating an operating agreement stating how your LLC will be managed.
If all members are equal managers, all member votes count as one vote each toward any decision-making process of the LLC, whether it is regarding finances, business decisions, or in a voting situation.
Suppose one LLC member decides to manage more frequently than other members. In that case, that manager is responsible for making day-to-day decisions.
The remaining members will not have decision power unless they enter an agreement with the managing member(s).
In either case of management structure, when there are multiple owners involved, each owner has equal rights to the assets and profits of the LLC.
The division of ownership does not have to be equal, but it can if that is what the members agree on.
Multi-Member LLC Asset Protection
Personal assets of multi-member LLC owners are protected if the LLC is sued. Each owner's personal assets are separate and distinct from the LLC's assets.
This protection applies regardless of how many members or owners there are.
Unlike a general partnership where partners are personally liable for debts of the business, an LLC is a legal structure that limits the personal liability exposure of each owner.
For example, if your company gets sued and owes $100,000 in damages to these creditors but only has $50,000 cash on hand, there's no problem because all you owe them is what you have in the bank.
But if you're operating as a general partnership and get sued for the same $100,000 in damages, then each partner is on the hook for $50,000 of that debt even if they didn't have anything to do with running the company when it got sued.
Multi-Member LLC Articles of Organization
Before it can become a legal entity, a multi-member LLC has to file Articles of Organization (or the Certificate of Formation in some states).
The Articles of Organization will be one of the two most important documents for the business formation; it is a public document and contains all of the important information about your LLC.
The Articles will contain:
- The name of the LLC (the "Fictitious Name")
- The address for service of process, which can be either an office or registered agent's address
- The name of each member
- The address for each member.
The Articles of Organization will also specify whether your business will be a member-managed LLC or a manager-managed LLC.
Multi-Member LLC Operating Agreement
Both multi-member and single-member LLCs need an operating agreement to operate according to the law.
The operating agreement ensures all parties understand how they should act when certain situations arise.
For a multi-member LLC, it is imperative to have an operating agreement in place. This is because the members of a multi-member LLC are considered business partners, and as such, they share LLC ownership in the company.
This can lead to disagreements if not everyone is on the same page. The operating agreement spells out how decisions will be made, how profits and losses will be shared, and how the LLC will be dissolved.
Having this document in place can help keep things running smoothly for your business.
Operating agreements should be reviewed and updated on a regular basis, significantly as the business changes.
If you don't have an operating agreement in place, or if your agreement is out of date, it's time to create one or update it.
There are free templates available online, but it's always the best idea to consult with a lawyer for guidance.
Do Multi-Member LLCs Pay Self-Employment Tax?
Yes. Multi-member LLCs pay self-employment taxes. Multi-member LLCs are required to pay self-employment tax on their share of the profits allocated.
Each multi-member LLC is treated as a separate legal entity for income tax purposes, so each must file their own Schedule C with the IRS at the end of each fiscal year.
A single return is filed for all members, which reports the LLC's combined business income, losses, and credits.
Does a Multi-Member LLC Need an EIN?
Yes. The employer identification number is required for filing taxes, hiring employees, applying for a business loan, and other business purposes.
Not only does an EIN help LLCs maintain their corporate veil, but it also helps the Internal Revenue Service (IRS) keep track of businesses and their tax filings.
How Do I Pay Myself in a Multi-Member LLC?
As a member of a multi-member LLC, you may receive payments from the company by taking distributions from your share of profits included in Schedule K-1.
You'll need to pay taxes on this amount on your personal income tax returns. You must also pay self-employment taxes on your share of LLC profits unless you're classified as an owner in a partnership tax classification. If the LLC is taxed as a corporation, you must pay income tax on your distributions just like any other shareholder would.
Are Multi-Member LLCs Subject to Franchise Tax?
It depends on the state's business law where you register your LLC. Some states do not levy franchise taxes on LLCs.
You should check with your state's Secretary of State website to find out if there is a franchise tax requirement and whether or not a multi-member LLC is exempt. If your state does charge a franchise tax, the fee varies from state to state.
Can a C Corp Own a Multi-Member LLC?
Yes. A C corporation can hold an LLC, though it may be difficult due to record-keeping and potentially complicated or non-existent state laws.
A C corp might own an LLC for a variety of reasons. It's essential to keep track of each firm's finances on its own accounting records.
If the goal is only to shift money from one place to another, additional liability will come with it.
Can an LLC Taxed as a Partnership Own an S Corp?
No. The requirement that shareholders be persons is one of several ownership limitations that apply to a business entity that opts to be taxed as an S corporation under IRC section 1362.
An LLC taxed as an S corporation cannot be owned by another business entity, nor can the ownership interest in the company be transferred to someone else except for death, divorce, or bankruptcy.
And while trusts are allowed to own shares of stock in corporations and other entities that elect subchapter C tax status, they are not allowed to own shares in LLCs taxed as S corporations.
All of these limitations are designed to protect the subchapter S election and prevent businesses from taking advantage of its tax benefits through complex ownership structures.
Can a Multi-Member LLC Be Taxed as an S Corp?
Yes. A multi-member LLC can elect an S corporation tax treatment. This is called a "check-the-box" election, and it's made by filing Form 2553 with the Internal Revenue Service.
However, if the LLC does not meet S corporation eligibility requirements, it will have to file as a C corp without any tax benefits.
Do All Members in LLC Need a Business License?
It depends. Some states require LLCs to have different business licenses, especially if it's a professional LLC.
In these cases, the chances are that all members of the PLLC need to be licensed professionals in order to be allowed to conduct business legally.
Can You Change a Multi-Member LLC to a Single-Member LLC?
Yes. To do that, you would file a form with the state and indicate that you are changing the LLC from a multi-member to a single-member LLC.
A leaving member (s) must sell the membership interest in the LLC to another member(s) or an outside third party.
There may be legal or tax consequences that you should consult with your lawyer about before making this change.
Do I Need a New Ein if I Change From Multi-Member LLC to Single-Member LLC?
No. Generally, the changes in membership don't require a new EIN because this number is attached to an entity and not to the co-owners.
However, if your tax structure changes (for example, switches from a C corp to an LLC), you will most likely need a new EIN.
Multi-member LLCs are an excellent option for business owners who want to take advantage of the many tax benefits and flexibility options within this type of entity.
However, before deciding if multi-member LLC is right, make sure you seek legal or tax advice first.
This will help ensure that you are not missing out on any of the benefits this type of business offers and avoid costly filing mistakes.