Sale of Membership Interest in LLC Form: Everything You Need to Know
Sale of the membership interest in LLC form may take place for several different reasons. Perhaps a member simply decides they want out, or the owner's situation may have changed so they decide to transfer their membership interest to another member.4 min read
Updated October 23, 2020:
Sale of the membership interest in LLC form may take place for several different reasons. Perhaps a member simply decides they want out, or the owner's situation may have changed so they decide to transfer their membership interest to another member. If the LLC only has two members and one will retain ownership, the process is not complicated.
Transferring LLC interest basically means that the member giving up ownership transfers all his rights to the other member, or members. The process may be different, however, depending on the law of the state where the LLC is registered.
Why LLC Membership Sales Are Different
In a corporation, shares of stock are issued and may be transferred freely or even gifted to other owners. In LLCs, however, this does not apply. Since LLCs are more like partnerships, you cannot force partnerships between people without their agreement. You can only transfer an LLC's ownership interests if all the other LLC owners agree, and even then, only if the state law allows for it.
Some states only allow the transfer of ownership interest, but not the transfer of the rights to control how the LLC is run. The only thing the new owner may receive is his share of profits and losses.
How to Get Out of an LLC
One method LLC owners use to get out of their interest in the company is abandonment. Not all states permit it, and it must also be allowed in the LLC's operating agreement. The LLC owner who is giving up their interest must take an action of some sort, such as sending a notice to the other owners that they are doing so. This does not require the other member's consent.
However, simply walking away from the LLC membership interest does not mean that person is no longer responsible for any liabilities they incurred before they abandoned the company. If that person was the guarantor of a debt owed by the LLC, they still have an obligation to the lender.
A much better way is for both members to mutually agree on the member's departure, and for the one who is leaving to officially assign his interest to the other member. This should be done even if the member who is leaving is not being paid for their percentage of ownership. Doing so involves a written document that can cover other issues, such as liens and legal restrictions.
Tax Implications of LLC Membership Sales
Whenever a sale or exchange takes place, as in the transfer of an interest in an LLC that involves compensation, the selling member usually has a gain or loss on the sale which is taxable. This may be true even if the member who is leaving the LLC does not receive any payment, because leaving the LLC may result in the departing owner's liabilities. The court system has set a precedent that any form of compensation, even if it is minimal, makes the transaction legally a sale.
How to Transfer LLC Membership Interest
There are several steps to properly transferring a member's percentage of ownership in an LLC:
- Consult the LLC's operating agreement, which is a contract between LLC owners that should have been drafted at the time of formation. Any rules or provisions in this agreement determine what you can do regarding the sale of a membership interest. For example, the agreement may require that a member sells his ownership interest at a fair price to the other members.
- If the LLC does not have a provision for ownership transfer in its operating agreement, you'll need to consult the state laws regarding LLC administration. Some states require the LLC to be completely dissolved when a member departs. Remaining members can create a new partnership at that time.
- A sales agreement must be drafted between the departing member and whoever is authorized to receive the member's share of the LLC. Sample documents for this may be found online, or the member can create it on their own. It should include details such as the date, sales price, and ownership interest percentage. Sign it, and have it notarized when the payment takes place.
- Proceed with the transfer in accordance with state law and the operating agreement. Other members should be provided with a formal written notice of the transfer, as well as the sales agreement. If members can't agree on a price for the ownership interest, it will need to be decided by a judge in civil court.
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