Multi Member LLC: Everything You Need to Know
A multi-member LLC is a limited liability corporation with multiple owners who share control of the company, and it stands in contrast with a single member LLC.10 min read
2. Single-Member vs. Multi-Member LLC
3. Asset Protection
4. Drawback of Multi-Member LLCs
5. Single-Member and Multi-Member LLC Benefits Example
Updated July 8, 2020:
A multi member LLC is a limited liability corporation with multiple owners who share control of the company, and it stands in contrast with a single-member LLC, wherein one person is in sole control of the organization.
History of Multi-Member LLC
In the 1990s, many states enacted LLC statutes for the first time, and did not permit single-member LLCs at all. If you lived in such a state, another person was necessary to form an LLC, and such partnerships were known as multi-member LLCs.
However, if your state did allow you to form a single-member LLC, one question of great importance was if states that did not allow single-member LLCs would recognize such organizations in states where they were allowed. However, by now, every state and Washington D.C. permit single-member LLCs, so this is no longer a problem.
That said, there is still some concern among legal scholars about whether the proprietor of a single-member LLC has the same liability protection as a member of a multi-member LLC. The statute regarding this seems clear, yet it may be many years before case law can develop to give lawyers the comfort they have with decades of case law regarding single-member LLCs. Ultimately, it seems probable that members of single-member LLCs will have no less legal protection than a partner in a multi-member LLC.
Single-Member vs. Multi-Member LLC
LLC formation has increased to become one of the top corporate structures chosen by start-up businesses. LLCs have been selected by many because, like corporations, they offer limited liability protection, while at the same time they retain desirable partnership attributes. Partnerships are formed by two or more people, yet LLCs are increasingly being formed by single individuals in the belief the protections of an LLC will benefit their business and them.
In order to properly understand this, it is important to grasp the concept of a partnership, as LLCs have a partnership-style structure. A partnership is a type of organization formed through a contractual relationship by two or more individuals or entities. These entities can consist of trusts, other partnerships, or corporations, and they can be made via written or oral agreement. Partnerships, having a distinct structure, require a separate tax filing from an individual's return.
If two or more individuals or entities do not create a partnership arrangement, the losses and profits the entity or individual makes are reported on the entity's or individual's tax return. For instance, if two people agree to create an independent contractor relationship but no partnership arrangement exists with respect to a business relationship, each person will report the profits or losses incurred on their individual returns under a Schedule A form.
That said, each business is unique and requires a proper review before moving forward with a particular form of organization. Should you consider an LLC a good option but are concerned about being a single-member LLC, a possible solution would be to consider taking on S Corporation designation.
When forming an LLC, whether a single-member or multi-member, there are numerous factors that you must consider. For instance, if you and your spouse are establishing an LLC, you will need to decide if both of you will be LLC members.
A mistake that many people make is assuming that the number of people involved in starting a company will be the determining factor in whether the business will be a multi-member or single-member LLC, which simply isn't the case. For example, it's common for multiple people to decide to form a single-member LLC. A sole business owner might also decide to establish their company as a multi-member LLC. Both options have strengths and weaknesses to consider before you choose your business structure.
Whether you're forming a single- or multi-member LLC, it's crucial that you have an operating agreement in place. With a multi-member LLC, you must be very careful when writing your operating agreement. The rights and responsibilities of company members should be described in detail, and your operating agreement can cover events such as:
- The death of a member.
- A disagreement between members.
- A split-up of the company.
When seeking to determine what structure to select, it is best to review all the options and not settle on the most popular form. It is important to note that a bill is currently being debated in Congress that would lead to a tax on all S-Corporate earnings, similar to the self-employment tax. Overall, weigh all your options before making a decision.
Another benefit of LLCs is that, similar to corporations, they have limited liability protection for their owners. LLC members' liability is limited to the investment they make to the company, thus giving LLCs an additional layer of protection from the actions of their members. A creditor of an LLC's member can only seek what is known as “charging order” against the member's interest in the LLC; they cannot directly attach the LLC's assets but rather only take payments from the member's distribution interest.
To illustrate this, we can image that, for example, if a member or group of members of the LLC were to incur debt, the creditor(s) could seek to reach the distributional interest and other monies owed by the LLC to the member, but they could not take control of the voting interests of the LLC.
Although asset protection exists for multi-member LLCs, recent court rulings have reduced the same protection for single-member LLCs. For example, in Shaun Olmstead v. Federal Trade Commission, the Florida Supreme Court decided that creditors can reach the entire interest of debtors related to their ownership of single-member LLC's, and thus the greatest advantage of single-member LLCs has been eliminated.
Drawback of Multi-Member LLCs
Before you form your multi-member LLC, you should also consider the drawbacks of this business structure, especially as they relate to taxes. With a multi-member LLC, you must file a partnership tax return, which means complying with the difficult partnership taxation rules.
On the other hand, the IRS treats single-member LLCs as disregarded entities. Most states also disregard single-member LLCs for tax purposes. Instead of the single-member LLC filing a tax return, the member will report the company's income on their personal return. The LLC member will also need to report the expenses of the business.
Single-Member and Multi-Member LLC Benefits Example
One of the biggest strengths of multi-member LLCs is that they are perfect for family-owned businesses. Imagine, for example, that you own a business and want to form a multi-member LLC to protect your personal assets. When establishing your company, you'll have the ability to list individuals in your family as members of your LLC, including:
- Your spouse.
- Your children.
- Your parents.
With a single-member LLC, you can simplify your taxes to an impressive degree. As an example, let's assume that you and another person own a variety of properties, each of which has been incorporated as an LLC. You could group these properties into one single-member LLC that is then owned by one multi-member LLC. Choosing this solution means you would no longer need to file an individual tax return for each piece of property.
Where involvement is concerned with an LLC owned by a married couple, often times only one spouse may take part in the running of the LLC, while the other may be entirely uninvolved. In such a case, adopting the single-member LLC model may seem natural. However, if a couple agrees the added protection of a multi-member LLC is preferable, they may find adopting a multi-member LLC model to be worthwhile.
In such a case, care should be shown in spelling out each other's right in the event of an irreconcilable disagreement, a split up, or death. Also, whoever is the second partner of the LLC should be able to show some kind of engagement with the company's decisions and operations. Otherwise, a court may later define this passive partner as a "sham member" and rule that the LLC is actually a single-member LLC. Understanding this and other general trends can help you choose if you and your spouse ought to both be listed as part of an LLC.
Although multi-member and single-member LLCs provide similar levels of protection for personal assets from company liabilities, the same does not apply to protecting the company from personal liabilities. When a person declares bankruptcy, the court has the power to seize many assets, including those related to the LLC.
If the LLC is multi-member, this seizure cannot include company assets without the agreement of other members of the LLC, as this would amount to the court taking one person's assets because of another's misconduct. On the other hand, if it is a single-member LLC, the assets related to it may be considered to be the same as the owner's assets and thus fair game for seizure and selling.
A case that occurred in Colorado may help you better understand bankruptcy rules for LLCs. In this case, the sole member of an LLC in this state filed for Chapter 13 bankruptcy. Later, the petition was converted to a Chapter 7 liquidation. The LLC itself was not initially considered a debtor in this bankruptcy case.
During the bankruptcy proceedings, the Chapter 7 trustee argued that they should be allowed to control the LLC, including selling the company's real property and distributing the profits from the sale to the bankruptcy estate. The trustee's reasoning was based on the fact that the debtor was the sole LLC member at the time of the bankruptcy filing. The single LLC member countered that the trustee should only be granted a charging order.
Eventually, the court decided that because the LLC had only one member at the time of the filing, ownership of the company belonged to the bankruptcy estate, and that the trustee could serve as a substitute member. Once the LLC member filed for bankruptcy, an ownership transfer approval was no longer required as it normally would be under Colorado law.
For tax purposes, a single-member LLC is easier to deal with, since no federal tax return is necessary unless the business chooses to be regarded as a corporation. A multi-member LLC, on the other hand, is required to file a tax return and give its members K-1 forms to file with their returns.
In the U.S., corporate income is often taxed twice insofar as not only the company must pay taxes, but also the shareholders. LLCs, on the other hand, only must pay income taxed on the owner's level. Because of this, on the company level, there is no difference between single-member and multi-member LLCs when income tax is involved.
When it comes to the personal level, a married couple may see a difference where the taxation of personal income is concerned. If they file separate tax returns and the LLC is owned by only one spouse, the LLC's profits can raise that individual into a higher tax bracket, bringing on a higher tax rate. However, this may not happen if they are both members of the LLC or if they file a joint tax return as a single-member LLC.
Some other income tax scenarios are as follows:
- If your LLC is solely owned by you, the IRS will classify it as a disregarded entity, and you will need to report all losses and profits on a Schedule C tax form "Profit or Loss from Business," which you will file with your 1040 form.
- If your business sells a product or provides a service, you will also have to pay self-employment taxes on your profits using the Schedule SE "Self-Employment Tax" form.
- If your company partakes in a passive business, such as rental, no self-employment taxes are required. Instead, your profits will be reported via the Schedule "Supplemental Income and Loss" form.
- The purpose behind self-employment tax is to pay for an individual's Social Security and Medicare Taxes. It is normally calculated after the individual determines their net earnings.
- For single-member LLCs, should they realize a profit, not only are those profits subject to the owner's income tax but also self-employment tax on the profits of the LLC.
- For multi-member LLC's, only managers and managing members are subject to self-employment taxes for the services rendered on the LLC normally through guaranteed payments, if the managers and/or managing members are individuals.
- Non-managing members are only subject to the respective portion of income tax that is notated on the member's Schedule K-1.
- For single-member LLCs, owners are potentially subject to more tax liability than multi-member LLCs.
- If you choose to keep some of your business profits in the bank at the end of the year, that money will still be subject to income tax.
- If your new business has two or more owners, the IRS will consider it a multi-member LLC for federal income tax purposes.
- If you own a single-member LLC, your LLC will not have to pay taxes. Instead, each owner pays a share of the LLC's taxes on their income tax return. The taxed amount is usually proportional to their share of the business.
- If you wish to divide your losses and profits differently, you'll need to ask for a special allocation from the IRS.
- For single-owner LLCs, taxes must be paid on the shared profits yearly, even if your money is left in your bank.
- If a multi-member LLC does not pay taxes, Form 1065 "U.S. Return of Partnership Income" must be filed to the IRS. This document allows the IRS to check to make sure that every owner is reporting their income properly.
- Two people who own several properties under separate LLCs may want to make them single-member LLCs owned by one multi-member LLC to avoid filing a separate tax return for each.
- Each LLC owner must attach Schedule K-1 "Partner's Share of Income, Deductions, Credits, etc." to their Form 1040, which shows their share of the LLC's profits and losses.
- In addition to the complexity of partnership taxes and the need to file an extra return, in several states levy income taxes on partnerships that are not levied on individuals.
When divorce occurs, couples often meet in court to divide up their assets, and an LLC can be particularly valuable. If a single-member LLC is owned by one of the parties involved, the other may be entitled to some or all its assets. How it is partitioned is decided on a case-by-case basis after a decent amount of litigation. As it concerns a multi-member LLC, it should be specifically stipulated in the operating agreement how much of the company is owned by each member. If so, the court may rule that each party will retain the share stated in the operating agreement.
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