What Is an LLC?
A Limited Liability Company (LLC) which is a commonly used organizational structure for small businesses and startups. This is mainly due to the business structure’s flexible management structure and quite easy to establish. This business entity offers you a tax structure of a partnership combined with the limited liability protection provided by a corporation.
Unlike corporations, LLCs are governed by state law at the state level, and their operation varies by state.
Single-Member LLC Characteristics
It provides tax benefits and protects personal assets from business liability for the member. It is taxed as a disregarded entity.
Reasons for Adding a New LLC Member
There are various reasons to change single-member LLC to multi-member LLC which could be for tax purposes as well.
Some of the reasons to add LLC members are:
- You have a new business partner;
- You require capital to expand your business;
- You may want to give an employee share ownership in your company.
Tax Consequences of Adding a Member to an LLC
LLC Taxed as a Partnership
If a member is added to your LLC and elects to be taxed as a partnership, it is subject to pass-through taxation. All incomes and expenses are reported on a separate return, IRS Form 1065, and does not have to pay taxes on its net profits. The owners are however required to pay taxes on the net profits of the company, irrespective of the fact if they receive profit distributions or not.
LLC Taxed as a C Corporation
If an LLC elects C corporation tax status, it is required to report all its incomes and expenses on a separate return, IRS Form 1120, and liable for corporate tax. This election will lead to the business entity being taxed twice.
In general, the owners of a C corporation who also perform work for the company must take W-2 salaries. These salaries are subject to payroll withholding taxes and deducted by the company as business expenses. If the owners take distributions of the company’s after-tax profits, this will be done via a dividend distribution. These distributions are not deductible as business expenses and both the dividends and salary is taxed as personal income.
LLC Taxed as an S Corporation
This LLC is taxed the same as a partnership and subject to pass-through taxation. No tax is payable on its net income and uses a separate return, IRS Form 1120S, to report all its incomes and expenses.
It reports each owner’s share of the company’s net profit or loss on the Schedule K-1 forms. The owners then need to report the amounts shown in their K-1 forms on their Schedule E forms, or on Form 1040.
It is also required to pay a W-2 salary to any owner who works for the company which is also subject to payroll withholding tax and deducted by the company as a business expense.
The owners are liable for federal and state taxes on the share of net profits they receive, but they do not have to pay self-employment tax.
Converting a Single-Member LLC to a Multi-Member LLC
If your LLC is taxed as a disregarded entity, and you add a member you will then be taxed as a partnership. The result of this is that you will need to close your books and records for the applicable year in question and file a short-year return to cover the period in which the LLC only had one member. You will also have to do the same for the rest of the year that covers the period in which the LLC had more than one member.
If your LLC already has an employer identification number (EIN), you have to file Form 8832 with the IRS to elect partnership taxation and provide the names of the new members.
If your LLC was formed within the past 75 days, you can possibly elect C or S corp tax status retroactively to prevent filing these short-year returns
Key Considerations When Deciding Between a Single and Multi-Member LLC
There are pros and cons for each type of LLC. The main differences are the number of owners or members and the way they are taxed.
An LLC with one member’s tax is simpler due to it not requiring a federal tax return unless it elects to be taxed as a corporation. As the 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 also no limitation on the number of members the LLC can have.
It can also choose to be taxed as an S corporation or a C corporation.
Single-Member LLC Ownership
It has one owner (member) who has full control over the company. The LLC is its own legal entity, independent of its owner.
Multi-member LLC Ownership
This LLC has two or more owners (members) that share control of the company. The LLC is its own legal entity which is separate from its owners. Unless it elects S Corporation tax treatment, there may be an unlimited number of members in a multi-member. The LLC may decide on how (what percentage of) profits and losses will be distributed among its members.
A Single-member LLC has one member, who is also considered the manager.
A Multi-member LLC, however, must decide if they would like the business to be member-managed or manager-managed.
In a member-managed LLC, the members participate in the work of the business. The company requires the majority approval of all of its members when making significant decisions, such as entering into contracts.
In a manager-managed LLC, the members agree on a manager, either a particular member or members of the LLC or a third-party, to whom they give authority to manage the day-to-day operations and decisions of the business.
Personal Asset Protection
Both types of LLCs protect the owners’ personal assets due to them being separate legal entities.
Owners may however be held personally responsible in certain situations.
Income Tax Treatment
Single-member LLC Default Tax Treatment
The income tax treatment of an LLC is that the owner reports the business’s profits and losses on Schedule C of IRS Form 1040, and the business does not report or pay taxes independently. The LLC owner also pays self-employment taxes (Social Security and Medicare) on all taxable income from the business.
The formation of an LLC:
- Choose a business name
- Apply for an EIN (Employer Identification Number)
- Designate a registered agent
- File Articles of Organization with the state in terms of the applicable state law
- Complete the Entity Classification Election Form (IRS Form 8832).
- Create an LLC operating agreement
- Open a business bank account
- Obtain the necessary business licenses and permits
- Know and abide by the relevant employment laws
- Learn the requirements to remain in good standing
A Single-member LLC usually has less-complex requirements to fulfill than a Multi-member one.
Legal Support to Add a Member to an LLC
If you want to add a member to your LLC, you are required to do the following:
- Add the names of the new members to your Articles of Organization.
- In your Operation Agreement, stipulate how the membership interests will change
- If your LLC has been paying taxes as a sole proprietorship, your accounting books and records must be closed when new members join your company.
- If your LLC adds new members during the tax year, you are required to file a short-year tax return for the current year.
Can you add members to a single-member LLC?
Yes, you can.
How do I add multiple members to my LLC?
You need to amend your Articles of Organization to include the names of the additional members and amend your LLC Operating Agreement to address the change in membership interests.
Is it better to be a single or multi-member LLC?
Both options have advantages and disadvantages and will depend on your specific circumstances.
How do I convert a single-member LLC to a multi-member LLC?
You need to check with the secretary of state on how to convert the LLC. The secretary of state is responsible for business filings.
Can a single-member LLC have multiple owners?
Can you change a single-member LLC to a multi-member LLC?
How to change a single-member LLC to multi-memberLLC?
How to change multi-member LLC to single-member LLC?
The only official requirement is the sale of the membership interest of the leaving member(s) to the remaining member and the filing of a new tax election form.