The multi-member LLC is a Limited Liability Company with more than one owner. It is a separate legal entity from its owners, but not a separate tax entity. A business with multiple owners operates as a general partnership, by default, unless registered with the state as an LLC or corporation.
Would it make sense for you to form your business as a multiple-member LLC?
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. I encourage you to speak with an attorney and accounting professional for guidance because all business structures offer advantages and disadvantages depending on your specific situation and your goals. For now, though, let’s take a closer look at the multi-member LLC structure.
Understanding the Multi-Member LLC
To give you a foundation of understanding before you start your conversations with legal counsel and your accountant or tax professional, I’m going to step you through some multi-member LLC details.
A multi-member LLC has two or more members. As an LLC, your company has the freedom to allocate percentages of your business’s profits and losses among owners as you choose. So, unlike a corporation, you may consider not only the money owners invest in the business, but also the time and effort they are putting into starting and running the business. Many states offer a lot of flexibility in who can own an LLC, too. Often, individuals (including non-residents of the U.S.), corporations, other LLCs, and groups may form an LLC.
Personal Asset Protection
The multi-member LLC structure provides some peace of mind that operating a business as a general partnership does not; it gives owners a degree of personal protection against any legal problems and debts of the business. Limited personal liability makes the this a good choice for business owners who want to sleep better at night!
In the case of lawsuits or the inability to pay debts, attorneys and creditors will typically go after the business’s assets. But realize, even with an LLC, the owners might still be held personally responsible under some circumstances. A few of the situations when personal assets might be at risk include if members have personally cosigned a business loan or guaranteed a loan, pledged personal property to secure a loan, committed fraud, or pierced the “corporate veil” by not fulfilling business compliance requirements.
Profit Distribution to Owners
In the LLC operating agreement, each LLC member’s share of profits and losses (distributive share) should be identified. Usually, each member’s distributive share will be in proportion to the percentage interest in the company he or she has. So, if you own 65% of the multi-member LLC, and your business partner Emma owns the other 35 percent, you will be entitled to 65 percent of your company’s profits and losses while Emma will be entitled to 35%. You do have the flexibility to divide profits and losses by way of a special allocation, using something other than percent membership interest as a way of calculating your distribution. I suggest you consider talking with your accountant to familiarize yourself with the IRS’s rules regarding special allocations before instituting them.
You can choose to operate your Limited Liability Company as either member-managed or manager-managed. Unless you specify a management structure in your formation documents, most states will consider your LLC to be member-managed. In a member-managed LLC, you and the other owners of your business have the authority to make important decisions, sign contracts, and manage the operations of your company. In a manager-managed LLC, however, LLC owners may still make important decisions, enter into contracts, and perform other duties, but they elect a manager or managers to run the day-to-day business operations. The particular roles and responsibilities of members and managers should be spelled out in your operating agreement, so everyone knows what is expected of them and what their level of authority is.
Digging into Income Tax Treatment
Federal Income Taxes
As a multi-member LLC, you have some flexibility in how your business’s income taxes are handled. By default, the IRS treats multiple member-owned LLCs as partnerships. Just like a single-member LLC, a multi-member LLC does not pay taxes on business income. Rather, the owners (members) individually pay income tax, based on their share of the profits, on their personal income tax returns. At tax time, the LLC must file an informational return (Form 1065, with Schedule K-1 prepared for each member), and each member must then report his or her earnings on Schedule E of Form 1040. As is the case with a general partnership, LLC members must usually pay self-employment tax (Social Security and Medicare tax) on their share of the LLC’s earnings.
You have other tax treatment options with an LLC, too.
Members can decide to have the business taxed as a C Corporation, whereby standard corporate tax rules apply. In other words, your company pays income tax on its earnings at the corporate tax rate via Form 1120 (U.S. Corporation Income Tax Return). If you expect you’ll keep a significant amount of your profits in your company, electing corporate taxation may save you and your co-owners some money. By doing so, you and the other owners won’t pay income tax at the individual level on those earnings. To elect C Corp tax status for your multi-member LLC, you must file Form 8832 (Entity Classification Election) when registering your business. Existing LLCs can also use Form 8832 to change their tax status to that of a C Corp.
Your multi-member LLC has the option of S Corporation tax treatment, too. With S Corp status, you are taxed as a partnership would be, with profits and losses passed through to members’ individual tax returns (filed via Schedule E of Form 1040). The difference, however, is that the owners need only pay self-employment tax on their salaries and wages, not on their profit distributions. When filing income taxes, the S Corp must file an informational return (Form 1120S) and shareholders (owners) should report their earnings from the company on Schedule E of their Form 1040. To elect S Corp tax status for your multi-member LLC, you must file Form 2553 (Election by a Small Business Corporation) when registering your business. Existing LLCs can also use Form 2553 to change their tax status to that of an S Corp.
Federal income tax rules can change, so regularly touch base with your tax advisor.
State Income Taxes
At the state level, tax laws vary for LLCs. Although most emulate the IRS tax rules, I suggest talking with a tax professional to ensure you 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 businesses operating as franchises. It is charged to LLCs, partnerships, and corporations as a fee for the privilege of forming and conducting business in the state. To find out if such a fee or others will apply to your multi-member LLC, contact your state’s Secretary of State office.
6 Basic Steps to Form a Multi-Member LLC
- Choose a business name – See if the name you want to use is available by checking your state’s Secretary of State database or doing a corporate name search. I recommend also using a trademark search tool to determine if any other businesses have filed for a trademark on the name.
- File your LLC’s Articles of Organization with your local state – To legally register your LLC in the state you want to be home to your business, you must file Articles of Organization with that state. The information you need to provide depends on the state. Typically, you must include the name and address of your LLC, the names of the members (owners) and managers of your LLC, the type of business you’ll be operating, theame and address of your registered agent.
- Create an LLC Operating Agreement – Although states rarely require an LLC Operating Agreement, it really is a must for a multi-member LLC. An operating agreement serves to describe the roles and responsibilities of owners and managers (if you’re a manager-managed LLC). It also lays out the ownership interests, profit distribution methodology, how to handle disputes between members, and other important details. A well-prepared operating agreement can help keep everyone on the same page and prevent misunderstandings.
- Apply for an EIN with the federal government – A unique identification number for your business, your Employer Identification Number (EIN) will enable you to open a bank account, file for permits and licenses, hire employees, and take care of other important business items. The IRS issues EINs at no charge.
- Apply for the necessary business licenses and permits – Depending on your type of business and where you’re located, you may need business licenses and permits to operate legally. Contact your Secretary of State office, county, and municipality to find out what requirements apply to you, or contact CorpNet to help you identify them.
- Open a separate bank account for your business – To ensure you don’t pierce the corporate veil that helps shield your personal assets from business liabilities, set up a bank account specifically for your LLC. LLCs and corporations are required to maintain the separation of business and personal finances.
Ongoing Compliance Obligations
After registering your business as a multi-member LLC, you will need to stay in compliance to maintain its status as a separate legal entity. Your LLC will have fewer formalities than a corporation, but you will need to tend to some ongoing responsibilities to keep your business in good standing. A few examples include:
- Renewing your licenses and permits
- Holding member meetings and documenting meeting minutes
- Filing annual reports
- Paying franchise fees
- Updating the state about major 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 your state’s rules or meet its deadlines could result in fines, penalties, lawsuits, and even suspension of your business.
CorpNet Can Help You Create Your New LLC
If you’ve determined forming an LLC is right for your real estate business, we can help! From serving as your registered agent to filing your Articles of Organization to obtaining your EIN, and keeping you in compliance, we make the process simple and ensure your paperwork is completed accurately and promptly.