Multi-Member LLCs: Are they right for your business?
Starting a business is a considerable risk. You are taking on expenses, and you’re not even sure the company will be successful. One way you can mitigate that risk is by sharing it with others. When you go into business, you have another person to bounce ideas off of, help with startup costs, and share responsibilities.
We’ll break down everything you need to know about a multiple-member LLC. You will learn:
MMLLCs are an excellent option for starting a business with friends and family. You can maintain a positive relationship while starting a business together if you take the proper steps in establishing a business.
LLC stands for limited liability corporation. LLCs allow business owners to disassociate themselves from their business financially and legally. You are essentially limiting your personal liability when you start a business.
Why would you want to separate yourself from your business? You are alleviating liability risks that your business can create for you. For example, if your business is in trouble and can’t pay its bills, the creditors will not come after your assets.
LLCs are a popular way to structure a business because they are simple. They also combine the benefits of partnerships and corporations. They are an excellent option for your real estate investing ventures.
There is not much difference between a multi-member LLC (MMLLC) and a single LLC. When you have an MMLLC, you are structuring your business so that multiple people are shielded from liabilities like lawsuits.
Multiple member LLCs are great for people wanting to join a business together. Not only can you share expenses and profits, but you can structure your business to shield all business owners equally.
The most significant difference is that a single LLC has a single member, and MMLLCs have multiple. But you will also notice big differences come at tax time. With single LLCs, the profits pass through the owner, and you pay your taxes as if you are receiving personal money.
With LLCs, there is an additional step. It’s not always clear to the IRS who gets what money. So you will need to fill out additional forms and documentation that state the amount of profit you claim. (Usually, this amount is proportional to your ownership, but check your partnership agreement.)
For example, if two owners each have a stake in an MMLLC, and the business earns $200,000, they both report $100,000 in profits on their tax returns. It isn’t an automatic pass-through like in a single LLC. You have to claim your portion of the income. We’ll go into the details of taxes below.
A partnership and a multi-member LLC are ways to structure your business if you’re working with others. Both business structures also have the added benefit of pass-through taxation.
The key difference is that a multi-member LLC offers liability protection. When you are a part of a partnership, the law does not consider you a separate legal entity. Partnership members cannot have asset protection and are more liable for litigation and debt.
People prefer multi-member LLCs for several reasons, but the most significant advantage is liability protection. Owners (or members as they are known) legally separate their personal and business assets. So if you run into an issue where someone sues your business, they can only go after your business.
You can also see liability protection benefits when you look at debt. If you have an issue paying the debt as a business, creditors can only go after your business assets. (There is an exception when you sign a personal guarantee for the business’s debt.)
Here are a few additional reasons a multi-member LLC might be beneficial for you:
People like LLCs because they provide flexibility. You can structure your business to be treated as a partnership, sole proprietorship, or S Corp for taxes.
The most significant disadvantage to multi-member LLCs is they are not foolproof. You can still be held personally responsible for a few reasons:
What’s worse, you can be held personally responsible if any member of your MMLLC does any of the above. So be careful who you go into business with when you start a multi-member LLC.
The other con comes from the bureaucratic elements of multi-member LLCs. It is more expensive and complicated to form a multi-member LLC.
You create a multi-member LLC at the state level. Every state is different in how they do this. Be sure to consult the specifics in your state before establishing your MMLLC. But here are the basic steps to establishing a multi-member LLC.
You need to choose a business name. You should double-check that your desired company name is available in your state’s database. Consider things like trademarks and website URLs as well when choosing your name.
You need an EIN, also known as an employee identification number. You apply for your new company’s EIN with the IRS. You need an EIN to open a company bank account, get permits and licenses, hire employees, and fill out future forms.
You need to register your LLC with the state. You do this with your preferred state’s secretary of state. You file Articles of Organization that includes:
Every state will have different requirements on these forms. So you may see some variation here.
State governments don't always require this, but you will be glad you have one if you’re starting a multi-member LLC. Operating agreements answer many questions: roles and responsibilities of owners, management duties, profit distribution, handling disagreements, and more. An operating agreement will keep your multi-member LLC running smoothly.
Check with your state and local government for requirements on this one. This one will vary. Be sure to stay on schedule with renewing these as well.
Keep your business separate from your personal expenses. It will help keep your liability protection more intact.
By default, multi-member LLCs are taxed like partnerships. (You can change this by requesting to be taxed like an S or a C corp.)
MMLLCs are pass-through entities, meaning your profits and losses will flow to your personal tax return. Your company doesn’t pay taxes, but instead, you do.
Even if you’re not paying yourself, each member must report income and losses from your multi-member LLC. The amount you claim on your taxes depends on your ownership percentage.
Here’s an example to break this process down. John and Amy co-own a bike shop. They do not have equal stakes in the shop: John owns 40%, and Amy owns 60%. Their annual profit totals $200,000. They each separately allocate their percentage of profit on their taxes. John allocates $80,000 in profit, and Amy allocates $120,000. They may not have all this money in their personal bank account, but the portion of the money is theirs.
Typically members fill out two forms for their federal tax return:
Beyond preparing your federal taxes, you will also have to pay state and local income taxes. This will vary from state to state, and some states do not have a state income tax at all.
If your multi-member LLC is considered a pass-through entity for tax purposes and is structured like a partnership, then you will pay your members with an owner’s draw. An owner’s draw is the money owners receive from profits.
You must establish a detailed owner-operating agreement. This will explain how much of an owner’s draw each member can receive. You will need to keep money in your multi-member LLC for operating and growth expenses. So you don’t want to take your full share of profits out. Your agreement details when, how, and to whom profits go during your fiscal year.
If you’re running your multi-member LLC like an S corp or C corp, then paying yourself is different. You are required to establish salaries and payroll using this classification. As an owner, you will also have to do payroll taxes. Consult an accountant if you go this route because it is more complicated. Multi-member LLCs structured like partnerships are far more popular for their simplicity.
If you’re investing in real estate with friends or family, a multi-member LLC can help. There are numerous benefits to forming a multi-member LLC for real estate investing: liability protection, tax benefits, protection from lawsuits, and more. If you’re using your real estate investment to rent out for vacation properties, you are exposing yourself to many risks. When you form an LLC, you are separating yourself from these risks. You are also gaining liability protection from debt. So if your rental property goes into foreclosure, your personal assets are kept separate from the multi-member LLC. It’s also a great way to make your business more legitimate, which will put all parties at ease.