Complete guide to multi-member LLC taxes
As a business owner, understanding the nuances of how your LLC is taxed is critical to making informed financial decisions.
This guide is designed to demystify the complexities surrounding multi-member LLCs and help you navigate the tax landscape with confidence.
What is a multi-member LLC?
A multi-member limited liability company (MMLLC) is a business structure that combines the flexibility and tax advantages of a partnership with the liability protection of a corporation.
It allows multiple owners – known as members – to benefit from operational flexibility and a shield against personal liability.
Multi-member LLCs operate under an operating agreement, which outlines the management structure, profit distribution, and key operating protocols.
While regulated at the state level, federal tax classification options include treatment as a partnership, corporation, or part of the owner's taxes.
Also read. How to file taxes for LLC for the first time
How many members can an LLC have?
In most states, there is no maximum limit on the number of members an LLC can have, making it a highly flexible structure for businesses looking to include multiple owners. This flexibility allows individuals, corporations, foreign entities, and other LLCs to become members.
However, the Internal Revenue Service (IRS) restricts LLCs opting for S corporation taxation to 100 shareholders, all of whom must be US citizens or resident aliens.
An important aspect for multi-member LLCs is the multi-member LLC ownership percentage. This percentage determines each member’s share of profits, voting rights, and liabilities, as outlined in the LLC’s operating agreement. Ownership percentages are often tied to each member's capital contribution, but LLCs are not required to distribute profits strictly according to ownership.
Advantages of multi-member limited liability companies
Multi-member LLCs offer several advantages that make them an attractive option for business owners.
Here’s a breakdown of the main pros of forming a multi-member LLC:
Limited liability protection
LLC members are generally not personally liable for business debts and liabilities. This means that personal assets such as homes, cars, and savings are protected from business-related lawsuits or debts.
Flexible management
Unlike corporations, which require a board of directors and officers, multi-member LLCs offer flexibility in management. Members can manage the business directly or appoint managers to handle day-to-day operations.
Pass-through taxation
By default, multi-member LLCs enjoy pass-through taxation, where profits and losses are reported on each member's tax return. This structure avoids the double taxation commonly associated with corporations, where profits are taxed at the corporate and individual levels.
Enhanced credibility
Forming an LLC can enhance the credibility of your business. Customers and vendors often perceive LLCs as more stable and professionally managed than sole proprietorships or partnerships.
LLCs can also be more attractive to potential investors. The structure provides a clear and formalized framework for investment, which can be attractive to those looking to fund a business.
How is a multi-member LLC taxed?
By default, the IRS treats multi-member LLCs as partnerships. Profits and losses are passed through to the members, who report them on their individual tax returns.
Partnership tax status avoids the double taxation often associated with traditional corporations and helps in managing small business tax preparation costs more efficiently.
If you have a single-member LLC, you also have an option to file your business taxes as a sole proprietor. Read this article to learn more: Tax classification for LLC: 4 options for small business.
Multi-member LLCs can also elect to be taxed as a C corporation or S corporation.
Filing taxes as a C corporation
A multi-member LLC can elect to be treated as a C corporation for tax purposes by filing IRS Form 8832.
This election significantly changes the tax structure:
1. Corporate income tax. The LLC pays corporate income tax on its profits at the corporate rate, which is separate from the personal income tax rates of the members.
2. Potential double taxation. Profits are typically taxed at the corporate level when earned and then taxed again at the individual level when distributed to members as dividends.
3. Deductible expenses. C corp status can provide certain tax benefits, such as a wider range of deductible business expenses.
In addition, C corps can retain a portion of their profits within the corporation without passing them all through to the members, potentially resulting in a lower overall tax liability for the members.
To report income, a C corporation files IRS Form 1120. After-tax profits may be distributed to members as dividends, which are taxed on members’ returns.
Filing taxes as an S corporation
Multi-member LLCs also have the option of electing S corp status for tax purposes.
The main S corporation benefits are the following:
1. Pass-through taxation. Similar to the partnership classification, an S corporation does not pay taxes at the corporate level. Instead, profits and losses are passed through to the members and reported on their tax returns.
2. Self-employment tax savings. One of the primary benefits of S corporation status is the potential for self-employment tax savings. Members of an S corp can be paid a reasonable salary for their work, on which payroll taxes are due.
3. Tax-free distributions. S corp shareholders can usually take non-dividend distributions tax-free since they have already been reported on their individual tax returns.
An LLC taxed as an S corporation files IRS Form 1120-S and issues each member a Schedule K-1, reporting their share of income.
To be taxed as an S corporation, an LLC must file IRS Form 2553.
How are LLC distributions taxed?
Distributions in a multi-member LLC generally follow the ownership structure outlined in the operating agreement, though members have flexibility in deciding how to divide profits.
For tax purposes, distributions are taxed as part of each member’s individual income based on their share of the LLC’s profits.
Taxation of distributions depends on the LLC's tax classification. For instance, distributions for a standard partnership-classified LLC are considered self-employment income, subject to self-employment tax rates.
State-specific tax considerations
Multi-member LLCs must also be mindful of state-specific tax laws and requirements.
Depending on the state, an LLC may be subject to state income tax. Some states follow the federal tax treatment, while others have their own rules for LLCs.
For example, in California, LLCs are subject to an annual income tax of 8.84% on taxable income, plus an additional LLC fee based on income over $250,000. In contrast, Florida does not impose any state income tax on LLCs.
Delaware, Texas and many other states l impose an annual franchise tax or a fee on LLCs, which is separate from income tax and often based on revenue or capital. If an LLC sells goods or services, it may also be subject to state sales or use tax.
In case an LLC has employees, it must comply with state employment tax requirements. Additionally, an LLC that owns or uses property might need to pay property taxes.
In addition to state taxes, LLCs should also be aware of any local taxes or business regulations that may apply in their particular location. For instance, New York City imposes an unincorporated business tax on certain LLCs operating within the city limits, adding another layer of tax responsibility for businesses located there.
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Register nowHow to hire employees as a multi-member LLC
Hiring employees in a multi-member LLC involves several key steps:
1. Obtain an employer identification number (EIN) from the IRS.
2. Register with state labor and tax departments for setting up accounts for state income tax withholding, unemployment insurance taxes, and obtaining necessary business licenses.
3. Set up payroll to withhold taxes from wages.
4. Comply with federal and state employment laws, including minimum wage, overtime, workers' compensation, and workplace safety standards.
5. Maintain accurate employment records, including I-9 forms.
6. Consider offering benefits and obtaining workers' compensation insurance.
How to change single-member LLC to multi-member
If you have a single-member LLC but wish to expand, you may wonder how to change a single-member LLC to multi-member.
This transition is straightforward – once you bring in a new member, you update the LLC's operating agreement to reflect the new ownership structure and file any necessary amendments with your state’s Secretary of State office.
Inform the IRS of this change, as it will affect your tax classification. By adding another member, the LLC will be reclassified from a disregarded entity to a partnership unless another tax election is made.
Prioritize strategic business tax planning and consult with a tax professional to ensure your tax entity choice perfectly aligns with your business goals. At TFX, we bring over two decades of experience guiding businesses through the complexities of tax laws. Since 2001, our tax team has helped small businesses comply with IRS regulations and discover ways to reduce their tax burden.
Your business structure is the key to tax savings.
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FAQ
Most states have no maximum number of members for an LLC. This means you can have as many members as your business needs.
Members can include individuals, corporations, other LLCs, and even foreign entities, giving you a wide range of options for structuring your business.
While there is typically no limit on the number of members, it's important to check your state's specific LLC regulations, as there may be some nuances.
If your LLC elects to be taxed as an S corporation, the IRS limits the number of shareholders to 100. In addition, all members must be US citizens or resident aliens.
Paying yourself from a multi-member LLC depends on the LLC's tax classification and your role in the organization. Here are the most common methods:
- In a typical multi-member LLC taxed as a partnership, the members receive distributions of profits. These distributions are typically based on a percentage of ownership or as agreed upon in the LLC operating agreement.
- If your LLC is taxed as an S-corp, you should pay yourself a reasonable salary for the work you perform. This salary is subject to payroll taxes, and the IRS will scrutinize these payments to ensure they are in line with industry standards.
- After paying a reasonable salary in an S corporation, any additional profits can be distributed as dividends, which are not subject to self-employment taxes.
- Remember, whether you receive distributions or a salary, the income must be reported on your tax return. The method of payment will affect how the income is taxed.
- Your LLC's operating agreement should outline the process for distributions, including the frequency and method of calculating each member's share.
- Maintain accurate records of all payments and distributions for tax purposes and to ensure compliance with IRS guidelines.
Here are the main drawbacks:
- With multiple members involved, decision-making can become more complicated. There may be disagreements among members, which can cause delays or conflicts in business operations.
- Profits must be shared among all members, which may result in lower individual earnings compared to a single-member LLC or sole proprietorship.
- Managing a multi-member LLC can be more complex than managing a single-member LLC, especially when it comes to aligning the interests and goals of all members.
- In certain situations, members can be held liable for the actions of other members. This could include financial mismanagement or legal issues arising from business operations.
- Multi-member LLCs face more complex tax filing requirements than single-member LLCs, particularly for LLC filing. The need to file additional forms, such as a Schedule K-1 for each member, adds to the administrative burden.
- If a member decides to leave the LLC, or in the event of a member's death, the process of dissolving or restructuring the LLC can be complicated and require significant legal and financial adjustments.
The control of a multi-member LLC depends largely on its management structure, typically outlined in the LLC's operating agreement. There are two primary management structures for multi-member LLCs:
- Member-managed LLCs: In this structure, all members participate in the day-to-day management and decision-making of the business. Each member has an equal say in operations unless the operating agreement specifies different levels of authority or decision-making power.
- Manager-managed LLCs: In this model, the members appoint one or more managers to handle the day-to-day operations of the LLC. These managers can be members of the LLC or outside parties. The managers make the day-to-day business decisions, while the members retain control over major decisions, such as amending the operating agreement or dissolving the LLC.
The operating agreement plays a critical role in determining who controls the LLC. It should clearly outline the management structure, the roles and responsibilities of each member or manager, and the process for making both day-to-day and major business decisions.
The operating agreement should also detail the voting rights of each member, which can be based on their ownership percentage or an equal distribution among the members, depending on what the members agree upon.
The tax payment process for a multi-member LLC depends on the tax classification chosen:
- For LLCs taxed as partnerships or S corporations, profits are not taxed at the entity level. Instead, each member pays tax on his or her share of the profits on his or her tax return.
- Members of an LLC may be required to make quarterly estimated tax payments if they expect to owe a certain amount of tax.
- If the LLC has employees, including members who actively work in the business, it must withhold payroll taxes and pay employer payroll taxes.
Disclaimer: This article is for informational purposes only and does not constitute legal or tax advice. Always consult with a tax professional regarding your specific case.
Susan Turcotte, a seasoned CPA with over 45 years of accounting experience, holds a Bachelor's in Accounting and a Master's in Taxation from Bryant College. See more
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