Are you running a business with a partner or considering taking that step?
Today’s guide explores the ins and outs of multi-member limited liability companies (MMLLCs). From their creation, structure, and taxation to comparing various multi-owner business structures, to outlining how to convert a single-member LLC into a multi-member LLC, I’ll cover everything you need to set your business up for success.
What is a multi-member limited liability company (MMLLC)?
Simply put, an MMLLC is a business structure where two or more people (called “members” in this case) own and manage a company together. If you have an LLC with more than one member, then you have an MMLLC.
Additionally, if you add your spouse as a member of your single-member LLC, then you have an MMLLC unless you live in a community property state.
What are the benefits of owning a multi-member limited liability company?
The biggest benefit to owning an MMLLC can be summed up in one word: flexibility. Unlike other multi-owner business structures, members of an MMLLC have flexibility in how they choose to manage the company. They also have flexibility in deciding how they would like the company to be treated for tax purposes.
How are members of a multi-member limited liability company taxed?
There are 3 options for how an MMLLC can choose to be taxed:
- Partnership: This is the default. If the members decide to opt for taxation as a partnership, then the business will be a pass-through entity, which means the business’ profits and losses will be reported on the members’ personal tax returns based on their ownership percentage. This avoids double taxation.
- S-Corporation: If the members elect to be taxed as an S-Corporation, they can save on federal self-employment taxes by earning a reasonable salary and then taking the rest of their income from the business as distributions, which aren’t subject to self-employment taxes. However, some states do have other requirements and taxes that can negate those tax savings, so business owners need to take that into account and understand how a corporation’s profit (and the owner’s income) is taxed in the state where the business is registered.
- C-Corporation: If the members decide the business should be taxed as a C-Corporation, then the business will pay corporate income tax and all members will pay taxes on the dividends they receive as well. Since this route means double taxation, it would only be advantageous to high-earners who would pay a higher tax rate on their personal tax return and who also want to avoid paying self-employment tax on their income from the business.
What’s the difference between a multi-member limited liability company and a general partnership?
Although both an MMLLC and a general partnership are both multi-owner business structures, there are several important differences between the two:
- Liability Protection
- In a general partnership, partners are personally liable for the debts and obligations of the business. This means if the partnership can’t pay its debts, creditors can go after the personal assets of the partners.
- In an MMLLC, members are usually not personally liable for the business’ debts or obligations. A member’s liability is limited to the amount they’ve invested in the business. This makes an LLC a safer choice in terms of protecting your personal assets.
- Paperwork
- In a general partnership, there often isn’t any formal paperwork like agreements, contracts, or filings required. However, a partnership agreement is highly recommended.
- For MMLLCs, you’ll need to file articles of organization with the state. You’ll also typically prepare an operating agreement that outlines how the business is managed (and by whom), how profits are shared, and how any disputes are resolved.
- Taxes
- Both general partnerships and MMLLCs are considered pass-through entities by default. As we’ve discussed, all this means is that the business doesn’t pay income tax. Instead, profits and losses are reported on the owners’ personal tax returns.
- However, an MMLLC has even more flexibility. The business can choose to be taxed as a partnership, which is the default, or as an S-Corporation or C-Corporation.
What’s the difference between a multi-member limited liability company and a C-Corporation?
While a C-Corporation and an MMLLC both offer limited liability protection for owners’ personal assets, a C-Corporation is very different from an MMLLC. It’s important to understand the differences in several areas:
- Ownership
- An MMLLC is owned by its members who can also manage the business directly or appoint managers to operate the business.
- A C-Corporation is owned by its shareholders but managed by a board of directors. The shareholders usually don’t participate in the business’ daily operations.
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Taxes
- As we’ve discussed, an MMLLC is a pass-through entity by default, which means the members report their share of profits and losses on their personal tax returns. This pass-through taxation prevents the double taxation that C-Corporations have to pay.
- Since C-Corporations are taxed as separate entities, they pay corporate income tax on their profits, and then the shareholders pay taxes on that income as well when the profits are distributed to them as dividends. This double layer of taxation can obviously be a disadvantage to this business structure.
- Profit Distribution
- In an MMLLC, members can decide how the profits will be distributed.
- C-Corporations have strict rules about profit distribution. For instance, dividends must be distributed based on the number of shares held by each shareholder.
How do I switch my business from a single-member LLC to a multi-member LLC?
Transitioning into an MMLLC from a single-member LLC requires a few steps:
- Operating Agreement: If you already have an operating agreement, you’ll need to update it to include the new members, their roles, responsibilities, and ownership percentages. If you don’t already have an operating agreement, you’ll need to create one to include that information.
- Paperwork: You’ll need to notify the state where the LLC is registered that the LLC has new members. Typically, this is done by filing an amendment to the LLC’s articles of organization.
- Taxes: By default, a single-member LLC is treated as a disregarded entity for tax purposes. Once the LLC becomes multi-member, it is automatically taxed as a partnership unless its members elect a different tax classification. As a partnership, the MMLLC will file a Form 1065, U.S. Return of Partnership Income and provide each member with a Schedule K-1, which details each member’s share of the business’ profits and losses.
- Employer Identification Number (EIN): Since you’ll be changing the ownership and structure of your business, you’ll need to apply for a new EIN.
- Banking Information: You’ll also need to update your business’ banking account information and any contact and ownership information you have with other financial institutions.
Understanding the differences between MMLLCs, general partnerships, and corporations can help you make informed decisions about your business’ future. Deciding how you want your MMLLC to be taxed and determining reasonable compensation (if you go the S-Corp route) is something that is best done alongside a certified public accountant who can make sure you’re making sound financial decisions and checking all of the boxes for the IRS.
The bottom line is that it’s always a good idea to invest in yourself and your business by learning as much as you can about your business’ structure and taxes. But it’s also a good idea to lean on professionals who can give you advice when important business decisions need to be made.
