As the term “multi-member” implies, a multi-member LLC is an entity with several individuals that act as co-owners. Multi-member LLCs are treated differently than single-person LLCs in many situations, such as when filing taxes.
In this article, we’ll walk you through a crash course on what it means to be a multi-member LLC, the benefits and drawbacks of operating as one, and any alternatives you can consider instead.
What Is a Multi-Member LLC?
Legally, a multi-member LLC is a Limited Liability Company created under state law with the Secretary of State and owned by at least two people and up to an unlimited number of members. A multi-member LLC differs from a single-member LLC primarily with respect to the number of members, but some other things set the two apart, too. The first thing to consider is who owns the LLC.
If you are part of a multi-member LLC, that means that several people may have a stake in the company’s daily dealings. If two or more LLC members don’t agree, they will need to vote or decide some other course of action to find a compromise between all members, as per the LLC operating agreement. This wouldn’t be an issue in a single-member LLC, where the single business owner would make all the decisions.
However, if that arrangement seems like it might cause too many problems, a multi-member LLC can also elect to have a single “manager” control the LLC’s decision-making process. This manager can be either a member of the LLC or an unrelated individual.
The other main difference between a multi-member LLC and a single-member LLC is how the entity is treated for federal income tax purposes. With a single-member LLC, the business works the same as a sole proprietor, but a multi-member LLC works the same as a general partnership.
This means that a single-member LLC owner can report their business earnings on personal 1040 tax forms, but a general partnership cannot. The owner(s) of the multi-member LLC must submit separate tax forms on behalf of the LLC itself.
How Many Owners Can You Have in an LLC?
In theory, you can have as many members as you want in a multi-member LLC, but as you might expect, the more members you have, the more difficult it is to reach a consensus when an issue arises. This could lead to leadership issues that might impact the success of the business.
The only exception to this rule is that, if you decide to apply for S Corporation tax treatment, you can only have a maximum of 100 members. Otherwise, you can have as many or as little as you want.
A single-member LLC, as the name suggests, usually only has one member. However, in some states, a single-member LLC can include two spouses who jointly own the business and operate it as a sole proprietorship.
What Are the Advantages of a Multi-Member LLC?
There are several benefits to becoming a multi-member LLC, and as you might expect, most of them have to do with liability protection. A multi-member LLC protects the members’ assets as the LLC is a separate entity from their personal affairs. If the company goes under for any reason, your own personal assets will be safe, regardless of whether you’re being sued, filing for bankruptcy, or another financial issue, unless personal guarantees are signed to secure a business loan.
The above is valid for all members of the LLC, too. However, do keep in mind that if one of the owners misuses company funds, they may still be liable since they’re breaking articles of the LLC.
Adding unlimited members to your LLC might also be considered a benefit, and these members don’t have to be people, either. You can add another LLC or a corporation as a member of your LLC.
Finally, a multi-member LLC does not need to pay the corporate tax that larger corporations are subject to.
What Are the Disadvantages of a Multi-Member LLC?
A multi-member LLC has some disadvantages, too, and these usually come down to asset protection as well. While an LLC is designed to limit personal liability to an extent, there are some exceptions to how far that protection extends.
The first example of this was mentioned in the section above. If you infringe upon the LLC terms as outlined in the articles of organization, you may face some personal liability. This can be true for all LLC members, even if only one member makes a mistake. For example, if one member of the LLC is caught falsifying records, the other LLC members may be held responsible for that, too, even if they weren’t a direct part of it.
Some of the ways that members of a multi-member LLC can get themselves (and their fellow members) into trouble include:
- Misrepresenting the business or committing fraud
- Keeping inaccurate records of business structure or proceedings
- Knowingly causing harm to other companies, entities, or people
- Using company funds for other purposes than what they were allotted for
Multi-member LLCs have a few other drawbacks besides the liability aspects. As we mentioned before, multi-member LLCs must do a little more work when filing their business taxes. Members of the LLC must pay self-employment taxes on the profits they make through the LLC, too.
How Are Multi-Member LLCs and Their Owners Taxed?
The members of a multi-member LLC are by default taxed similarly to single-member LLCs, but because all of the members are considered owners, they have a few extra hoops to jump through. Just like a single-member LLC, a multi-member LLC does not pay taxes on business income. We just mentioned above that all multi-member LLC owners must pay self-employment taxes, but this is only true for the members themselves, not the employees.
Unfortunately, a person cannot be both a member of the LLC (partnership) and an employee of that LLC at the same time. If they want to file as an employee to avoid paying self-employment taxes, they must change their tax status.
As we mentioned earlier in this article, a single-member LLC can decide to file their taxes as a “disregarded entity” rather than a partnership, by reporting the LLC’s profits and losses on a Schedule C. There is an exception to this rule that applies in some states where a spousal partnership can also apply for this consideration.
As an LLC that is taxed as a partnership, each member pays income tax based on their share of the profits. At tax time they will file an informational return, Form 1065 Schedule K-1, with their personal income tax returns.
A spousal partnership can be considered a single-member LLC in these states as long as the married couple each own an equal share in the business. However, your spouse should only be added to your single-member LLC to make it a multi-member LLC if they intend to handle their share of the work (and profit). This is also one of the only times that a multi-member LLC can be treated as a disregarded entity.
S Corporation Status
An LLC with multiple owners can decide to file for S Corporation Status if they meet specific criteria. S Corporation status allows the LLC’s members to be both employees and managers of the LLC. Ordinarily, if the LLC was filing taxes as a partnership (the default state), this would not be possible.
There are both benefits and drawbacks to filing for S corporation status as an LLC. Doing so does not make your LLC a corporation, but it does change how you and your partners are paid and taxed.
The first benefit of S corporation status is obvious. If you’re an employee of your business, that means you can also pay yourself a salary as well as receive a portion of the business’s profits as distributions. This salary is subject to both federal income tax and payroll taxes which are a combination of Social Security and Medicare taxes.
Additionally, while an LLC is considered a pass-through business entity whether it’s taxed as a partnership or an S corporation, how much is permitted to pass through depends on which one you choose. In other words, if you exceed a certain amount of profit with your business, you no longer qualify for the pass-through deduction.
This is another place where filing as an S corporation comes in. An S corporation has no upper limit on the business’s pass-through capabilities, though it does have some other variables that help you deduce how much of this profit passes through to the owners. Essentially, if your LLC exceeds a certain amount of profit in a year, you can deduct more from your taxes if you file as an S corporation.
To file your LLC’s taxes as an S corporation, you must meet the following criteria:
- Your LLC cannot have more than 100 individual members
- All of your LLC’s members must be people – no partnerships or corporations
- The LLC mush have only one class of stock (no special privileges to certain members and not others)
- All members must live in the United States
To elect S corporation status, file Form 2553 with the IRS, Election by a Small Business Corporation.
C Corporation Status
LLCs can also elect to be taxed as a C corporation, which may provide tax savings. Regardless of which tax election you choose for your LLC be sure to talk to an accounting professional. One of the drawbacks for most people who elect to be taxed as a C corporation tax is because the owners are subject to double taxation. First is the 21% of corporate tax that must be paid on profits and then the shareholders must pay income tax on their personal tax return for any dividends received at the capital gains tax rate.
C corp status can be elected by filing IRS Form 8832, Entity Classification Election.
How Do I Pay Myself as a Multi-Member LLC?
Paying yourself as a member of a multi-member LLC might seem complicated at first, but in reality, it’s relatively easy. The share of the profits you will receive should have been outlined in the articles of organization when you created the LLC.
For example, if you and two others decided that you would each take 30% of the business’ profits and your business makes $300,000 in profits that year, you would take $100,000 of that profit. You and the other members of the LLC would then need to pay taxes on those profits. If you are classified as an S corporation, you will need to pay self-employment tax on your salaried pay, too.
As many things in the business world are, a multi-member LLC is a complicated concept with many nuances and things to learn. However, by taking the time to learn the ins and outs of multi-member LLCs, you now know what the benefits of becoming one are, what drawbacks you might see, and whether doing so will benefit your business or not.