1. Single-Member LLC Characteristics
2. Adding Members to a Single-Member LLC
3. Tax Consequences of Conversion
4. Partnership Taxation

Updated June 28, 2020:

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." LLCs are a common organizational structure for small businesses because of their flexible management structure and ease of establishment. This 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.

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 Conversion

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

Partnership Taxation

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.

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