Are you starting a business with some colleagues or friends? Or do you have an existing business and want to add some partners so you can grow your company? In either case, the multi-member LLC business structure may be a good option to consider. A multi-member LLC is a Limited Liability Company with more than one owner. It is a separate legal entity from its owners (a.k.a. members), while by default, income tax obligations are on a pass-through basis to the LLC’s members (similar to Partnership).
Let’s take a closer look at why many companies with multiple owners choose the entity type.
Understanding the Multi-Member LLC
Few Ownership Restrictions
A multi-member LLC has at least two members, and there is no limit to how many members it may add. Many states offer a lot of flexibility in who can own an LLC, too.
Examples of who may typically be an LLC member include:
- Individuals (including non-residents of the U.S.)
- Corporations
- Other LLCs
- Foreign entities
Business owners should check their state’s requirements and federal tax regulations to determine member eligibility and other applicable rules.
Personal Asset Protection
The multi-member LLC structure provides business owners with a degree of personal liability protection against any legal problems and debts of the business. Unlike partners in a General Partnership whose personal assets (bank accounts, retirement savings, home, car, etc.) are at risk if their business cannot pay its bills or gets sued, generally, members of an LLC are only responsible up to their initial financial investment in the business entity.
Typically, attorneys and creditors pursue the LLC’s assets alone. However, individual members might still be held personally responsible under some circumstances. Situations in which members’ personal assets might be at risk include if the individuals have personally cosigned or guaranteed a business loan, pledged personal property to secure a loan, committed fraud, or pierced the “corporate veil” by not fulfilling business compliance requirements.
Tax Flexibility
By default, a multi-member LLC is taxed as a Partnership, with its profits and losses flowing through to its members’ personal tax returns. The LLC does not pay corporate income tax; instead, its members report and pay income tax based on their percentage of ownership (or according to a special arrangement agreed upon in the LLC operating agreement). When taxed in this manner, members must also pay self-employment taxes (Medicare and Social Security) because LLC members do not receive paychecks from their company, and the LLC pays no portion of those taxes. The LLC must file an information return—Form 1065, U.S. Partnership Return of Income—with the IRS and send each member a Schedule K-1, Partner’s Share of Income, Deductions, Credits, etc. Then, each member must report the information from their K-1 on their Schedule E of their Form 1040.
Alternatively, a multi-member LLC may elect to be treated as an S Corporation. To elect S Corporation status, an LLC must meet the IRS’s eligibility requirements, including having no more than 100 shareholders and no Partnerships, Corporations, certain trusts, or non-resident aliens as shareholders. An LLC with an S Corporation election continues to be taxed as a passthrough entity, however, Medicare and Social Security taxes (FICA) only apply to wages and salaries. Profit distributions the owners receive are not subject to those taxes, so S Corp status might potentially reduce the individual’s personal tax burden.
An LLC must file IRS Form 2253, Election by a Small Business Corporation, to elect S Corp tax treatment, and when filing federal income taxes, the S Corp must file an informational return (Form 1120S) and shareholders should report their earnings from the company on Schedule E of their Form 1040.
Another tax option is election for treatment as a corporation (i.e., C Corporation). Although less commonly chosen than the S Corp election, being taxed as a corporation may benefit some multi-member LLCs. With corporation tax treatment, the business is responsible for reporting and paying income taxes at the corporate rate, and its shareholders are responsible for reporting and paying taxes on their wages (or salaries) and profit distributions on their personal tax returns. This approach means that some business income gets taxed twice because profits are taxed at the corporate level first. Then, any portion of those profits distributed to shareholders is taxed again at the individual level. Still, if the corporate tax rates (federal and state) are lower than the shareholders’ personal income tax rates, election as a Corporation might result in a lower overall tax bill than if the LLC were taxed on a passthrough basis. An LLC must file IRS Form 8832, Entity Classification Election, to request treatment as a corporation for tax purposes.
At the state level, tax laws vary for LLCs. Although most emulate the IRS tax rules, it’s wise for business owners to speak with a tax professional to ensure they understand how income taxes will be applied. Some states levy other fees on LLCs, such as franchise taxes. Contrary to the name, a franchise tax isn’t specific to franchised businesses. It is charged to LLCs, partnerships, and corporations as a fee for the privilege of forming and conducting business in the state. The state’s Secretary of State office can advise if that fee (or others) applies to LLCs in its jurisdiction.
Freedom to Distribute Profits As Desired
The company’s LLC operating agreement should identify each member’s share of profits and losses (distributive share).
Some multi-member LLCs calculate each member’s distributive share in proportion to their percentage interest in the company. For example, if Sara owns 65% of the multi-member LLC’s interests and her business partner Rebecca owns the other 35%, Sara would be entitled to 65% of the company’s profits, while Rebecca would be entitled to 35%.
However, a multi-member LLC isn’t bound by that method of distributing profits. It may divide profits and losses by special allocation, using something other than percent membership interest to calculate members’ distributive shares. So, unlike a Corporation, a multi-member LLC may consider factors other than monetary contributions—such as the time and effort members put into business operations—when deciding how to divide profits.
Management Options
A multi-member LLC can operate as either member-managed or manager-managed. Unless the LLC’s formation documents state otherwise, most states will consider the entity member-managed. In a member-managed LLC, its members have the authority to make important decisions, sign contracts, and manage the day-to-day operations of your company. In a manager-managed LLC, LLC owners may still make decisions, enter into contracts, and perform other duties, but they elect a manager (or managers) to run the daily business operations. The LLC operating agreement should spell out members’ and managers’ roles and responsibilities so everyone knows what is expected of them and their authority level.
Credibility
Forming a registered business entity like a multi-member LLC can help instill confidence that a company is legitimate and trustworthy. Companies that operate as Sole Proprietorships or Partnerships may find it challenging to secure funding and financing because some lenders and investors consider them riskier propositions. Also, the authority to use “LLC” at the end of a business name indicates that a business is official, which may help customers and vendors feel more secure engaging with the company.
8 Steps to Form a Multi-Member LLC
1. Choose a Business Name
Before registering an LLC, business owners should do a business name search to see if the name they want to use is available. Most states make their business name database available online. It’s also recommended that a trademark search be done to determine if any other businesses within the U.S. have filed for a trademark on the name.
2. Designate a Registered Agent
A multi-member LLC must appoint a registered agent in its home state (and any other states where it has operations). A registered agent is an individual or company authorized to accept service of process and essential government correspondence and documents on behalf of a company.
The types of communications and documentation a registered agent might receive for an LLC include:
- Subpoenas for information
- Court summonses
- Notices of lawsuits
- Official federal and state government correspondence
- Corporate filing notifications (e.g., annual report)
- Wage garnishment notices
- Notices from the IRS and other tax authorities
3. File Your LLC’s Articles of Organization
To legally register an LLC in a state, the business owners must file Articles of Organization with the Secretary of State office. The information required depends on the state.
Typically, states request the following details:
- Name and address of the LLC
- Names of the members (owners) and managers
- The LLC’s business purpose (often, companies make a general statement that indicates the entity’s purpose is to engage in lawful activities for which an LLC may be organized under the state’s regulations)
- Type of business (e.g., real estate development, beauty salon, vehicle repair shop, etc.)
- Name and address of the LLC’s registered agent.
4. Create an LLC Operating Agreement
Although states rarely require an LLC Operating Agreement, it is a must for a multi-member LLC. An operating agreement describes the roles and responsibilities of owners and managers (if the LLC is manager-managed). It also lays out ownership interests, profit distribution methodology, how to handle disputes between members, and other important details. A well-prepared operating agreement can keep everyone on the same page and prevent misunderstandings.
5. Apply for an EIN With the Federal Government
An Employer Identification Number (EIN), a unique identification number, is an LLC’s federal tax ID number. If a multi-member LLC is taxed on a passthrough basis, LLC members should include their business’s EIN on Schedule E of their 1040 tax return. The LLC will need an EIN for other purposes as well, such as opening a bank account, filing for permits and licenses, hiring employees, and taking care of other important business items.
6. Apply for Business Licenses and Permits
Depending on the type of business and where an LLC is located, it may need business licenses and permits to operate legally. Business owners can contact the Secretary of State office, county, and municipality to learn their company’s requirements. LLCs in certain industries (such as agriculture and aviation) might also need a federal license.
7. Open a Separate Bank Account for Your Business
LLCs are required to maintain the separation of business and personal finances.
An LLC should never commingle the business’s finances with its owner’s monies! If an LLC’s members pay for personal expenses from the business bank account or personally guarantee a loan in the LLC’s name, they risk piercing the corporate veil that helps shield their personal assets from business liabilities. That’s why setting up a bank account (and credit accounts) specifically for the LLC is critical.
8. Keep Up With Ongoing Compliance Obligations
After registering a business as a multi-member LLC, members must keep the company compliant to maintain its status as a separate legal entity. An LLC has fewer formalities than a corporation, but there are some ongoing responsibilities to maintain good standing with the state.
Compliance examples for an LLC include:
- Renewing your licenses and permits
- Holding member meetings and documenting meeting minutes
- Filing annual reports
- Paying franchise fees
- Updating the state about significant changes within your company (such as when you add members or members leave)
- Filing taxes
Requirements vary from state to state. Failure to comply with the state’s rules or meet its deadlines could result in fines, penalties, lawsuits, loss of members’ personal liability protection, and even suspension or dissolution of the business entity.
Does It Make Sense to Form a Multiple-Member LLC for Your Business?
To arrive at that answer, you need to consider how choosing that business entity type will impact you legally, administratively, operationally, and from a tax perspective. Every business structure has advantages and disadvantages depending on the specific situation and the entrepreneur’s goals. Speaking with an attorney and accounting professional for guidance can help you make an informed decision.
Other resources that can help you understand the potential pros and cons of various entity types:
