Single-Member LLC to Multi-Member LLC: Everything You Need to Know
Converting a single-member LLC to multi-member LLC occurs when the ownership stake of an LLC is divided among additional owners, referred to as "members."4 min read
2. Adding Members to a Single-Member LLC
3. Tax Consequences of Adding a Member to an LLC
4. Partnership Taxation
5. Is it better to be a single-member LLCs or multi-member LLCs?
6. Legal Support to Add a Member to an LLC
Updated September 6, 2021:
Converting a single-member LLC to multi-member LLC occurs when the ownership stake of a limited liability company is divided among additional owners, referred to as "members." Limited liability company LLC is a common organizational structure for small businesses because of their flexible management structure and ease of establishment. This business entity offers the tax structure of a partnership combined with the limited liability protection of a corporation.
Single-Member LLC Characteristics
An entrepreneur may form a single-member LLC to enjoy tax benefits and protect personal assets from business liability. An LLC can have any number of members and can choose to be taxed as a C corporation, S corporation, partnership (multi-member), or disregarded entity (single-member). A single-member LLC is taxed as a disregarded entity, and a multi-member LLC as a partnership by default unless the LLC elects C corp taxation by filing IRS Form 8832 or S corp taxation by filing IRS Form 2553.
Unlike corporations, LLCs are governed at the state level, and their operation varies by state. However, in most states, rules about adding new members to an LLC are the same.
Adding Members to a Single-Member LLC
LLC members are listed in the articles of organization when the LLC is formed. If you created an operating agreement for your LLC, it may detail the procedures for adding members, which should be followed if you opt to do so. If no such procedure exists, the new member or members must agree on the terms of membership with the existing LLC member, including the new members' ownership percentages. The written agreement must be signed by both new and existing members.
To convert a single-member LLC to a multi-member LLC, you’ll need to check with the secretary of state. The secretary of state is responsible for business filings. Because each state requires an operating agreement or for all owners to be on the same page regarding what tasks, responsibilities, and decision-making authority each individual has. This will help with any future disputes among the members.
In addition, the LLC member can transfer a portion or all of his or her membership interests to another individual if he or she has the power to do so under the operating agreement. The new member would have to comply with the terms of this assignment as well.
The articles of organization must be amended to reflect the new member, and if applicable, the operating agreement must detail the change in membership interests and address other potential issues.
Tax Consequences of Adding a Member to an LLC
Although most property exchanges are subject to tax gain or loss for the parties involved, this is not true for contributing funds to an LLC in exchange for membership interest. That's because an LLC is considered a disregarded entity for tax purposes, so ownership transfers do not carry federal tax consequences.
If you add a member to your single-member LLC and are currently taxed as a disregarded entity, you will now be taxed as a partnership. This means you'll need to close your books and records for the year in question and file a short-year tax return to cover the period in which the LLC has only one member, along with another short-year return that covers the period in which the LLC had more than one member.
If your single-member LLC already has an employer identification number (EIN), you must file Form 8832 with the IRS to elect partnership taxation. You'll also need to provide them with the names of your new LLC members.
If your LLC was formed within the past 75 days, you can often retroactively elect C or S corp tax status to prevent the need for these short-year returns. In Revenue Ruling 99-5, you can seek guidance about what happens when:
- The owner of a single-member LLC sells half of his or her interest to another person
- A new member contributes cash or property to a single-member LLC in exchange for an ownership stake
Like a disregarded entity, a partnership is subject to pass-through taxation. Profit and losses are reported on each member's individual income tax return. The LLC does not pay income tax but provides each member with a Schedule K-1 detailing his or her percentage of the business profits and losses.
Partners can take guaranteed payments that are deducted as a business expense as well as cash draws on their share of net profits, which are not deductible. Partners don't need to withhold payroll taxes but may need to make personal estimated income tax payments.
Is it better to be a single-member LLCs or multi-member LLCs?
The first step you’ll want to consider is your ownership interest:
- Management/ Business structure
- Income tax treatment
- Asset protection
There are pros and cons of each business entity. The main difference between the two is the number of owners or members. Another difference is the way they are taxed. A single-member LLC is easier to tax because it does not require a federal tax return unless the business elects to be taxed as a corporation. As a sole proprietorship owner, you have full control over the company. Whereas a multi-member LLC has the authority to decide what percentage of profits and losses will be shared among its members. There is no limit on the number of members.
They can choose to be taxed as an S corporation or C corporation. The income is stated on the tax returns of the member. All LLC members must file a tax return and schedule K 1 forms to its members to include with their returns.
Legal Support to Add a Member to an LLC
When choosing what limited liability is appropriate for your business consult with an attorney or other trusted advisors. They can provide answers to your questions and help as guidance. If you need help with adding a new member to your single-member LLC, you can post your legal need on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.