Multi-Member LLC: Taxes, Ownership and Adding a Member

A multi-member LLC is a limited liability company with two or more owners, called members. Under state law it works like any other LLC: the company owns its assets and owes its own debts. Under federal tax law it is a partnership by default, so it files its own return, Form 1065, and gives each member a Schedule K-1 showing their share of the profit, which they report and pay tax on themselves.

The extra owner is what makes this kind of LLC different. Two or more people now share profit, decisions and the risk that someone wants out, and the IRS treats the company as a separate filer. This guide covers how a multi-member LLC is taxed, what its operating agreement has to settle, the special rules for married couples, and how to add a member or transfer an interest, including what that changes at the IRS.

What a multi-member LLC is

No state has a separate form for a multi-member LLC. You file the same articles of organization (or certificate of formation) as a one-owner company, and the difference lives in the operating agreement and in how the LLC is taxed. Members can be individuals, other LLCs, corporations or trusts, in any number, and they can own unequal shares: a 70/30 split between a founder and an investor is common. A company owned by another company is covered in can an LLC own another LLC.

The liability protection is the same as for a single-member LLC: a member is generally not personally liable for the company's debts just because they are a member. What changes with more owners is the tax filing and the need for written rules between them. If there is only one owner, the rules are different, and single-member LLC explains them.

How a multi-member LLC is taxed by default

The IRS classifies a domestic LLC with at least two members as a partnership unless it files Form 8832 to be taxed as a corporation. A partnership pays no federal income tax of its own. Instead:

• The LLC files Form 1065, the partnership return, by the 15th day of the third month after its tax year ends: March 15 for a calendar-year company. It reports the year's income, deductions and each member's share.
• Each member gets a Schedule K-1 showing their share of income, deductions and credits, and reports it on their own return.
• Members are taxed on their share whether or not it is paid out. If Cedar Row Studio LLC earns $100,000, splits it 60/40 under its agreement and keeps $30,000 in the bank for equipment, the members still report $60,000 and $40,000. This catches many new co-owners off guard, and it is why many operating agreements require a tax distribution each year.
• Self-employment tax applies to the share of a member who works in the business, much as it would for a general partner. A member who is closer to a passive investor may be treated differently; how the rule applies to a given member is a question a CPA or tax preparer can answer.
• Guaranteed payments are what the LLC pays a member for work or for the use of their money in amounts fixed without regard to the company's profit, such as a set monthly amount to the member who runs the shop. The LLC deducts them on Form 1065 and the member reports them as income. The IRS says partners are not employees and get no W-2, as how to pay yourself from an LLC explains.

Most states with an income tax want a state partnership return as well, and a few tax the LLC itself. The year-by-year filing calendar, federal and state, is in how to file LLC taxes.

Electing S corporation or C corporation taxation

The partnership default is not permanent. A multi-member LLC can file Form 2553 to be taxed as an S corporation, which puts working members on payroll and can change how much self-employment tax they pay, or Form 8832 to be taxed as a C corporation. An S election needs every member to be an eligible shareholder (individuals, estates and certain trusts and exempt organizations, with no nonresident aliens and no more than 100), so an LLC with a corporate or partnership member generally cannot make it. After a classification change, the LLC generally cannot change again for 60 months. The trade-offs are laid out in LLC vs S corp; many owners have a CPA run the numbers before electing.

The operating agreement does the heavy lifting

With one owner, an operating agreement is useful. With several, it is the document that decides what happens when partners disagree. State law fills any gap with default rules, which may not match what the members thought they agreed. A multi-member LLC's agreement usually covers:

• Ownership percentages and how they change when someone contributes more.
• Capital contributions: what each member put in (cash, equipment, work) and whether more can be required.
• Profit and loss allocations and distributions, including any yearly distribution to cover the members' taxes.
• Voting: which decisions need a majority and which need everyone, such as selling the business or admitting a member.
• Transfer and buyout rules: whether a member can sell to an outsider, a right of first refusal for the others, and how an interest is valued when a member leaves, divorces, becomes disabled or dies.
• Management: who runs the company day to day, and who can sign contracts and open accounts.

Banks often ask for the agreement before opening an account for a multi-member LLC, to see who can sign. What else belongs in it, and the options for getting one written, are in do you need an operating agreement.

Member-managed or manager-managed

In a member-managed LLC, every member can act for the company and take part in running it. That suits a small company where all the owners work in the business. In a manager-managed LLC, the members appoint one or more managers (members or outsiders) to run it, and the other members act more like shareholders. That suits a company with investors who should not be signing contracts. Many states ask which structure you chose in the articles, and the operating agreement sets out the details.

Husband and wife LLCs: community property and joint ventures

An LLC owned by two spouses has two members, so by default it is a partnership and files Form 1065 like any other. Couples who run an unincorporated business together can elect to be a qualified joint venture and file two Schedule Cs instead, but the IRS says that election covers only businesses the spouses own as co-owners and not in the name of a state law entity such as an LLC. Forming the LLC takes the qualified joint venture off the table.

The exception is community property. Under Revenue Procedure 2002-69, when an LLC is owned only by a married couple as community property, no one else is treated as an owner and it is not taxed as a corporation, the IRS accepts whichever treatment the couple uses: a disregarded entity (one Schedule C, as if one owner) or a partnership (Form 1065). Once chosen, switching is treated as a conversion of the entity, so many couples decide this with a tax preparer at the start. The IRS's Publication 555 lists nine community property states:

Alaska, South Dakota and Tennessee let couples opt into community property by agreement or trust. Publication 555 does not cover those arrangements, so whether a couple there can use the same treatment is a question for a CPA. In every other state, a spouse-owned LLC is a partnership unless it elects corporate taxation.

How to add a member to an LLC

Say Cedar Row Studio LLC, owned by one designer, brings in a second designer for 30 percent. The steps are much the same in any state:

1. Read the operating agreement. It may already say how a member is admitted, who must approve, whether existing members get first refusal and how a new interest is priced. If there is no written agreement, state law decides, and writing one now is part of the job.
2. Get the members' consent. Many state LLC laws require the consent of all members to admit a new one unless the agreement says otherwise. Put the approval in a signed written consent.
3. Agree the price and the new percentages. The new member can buy part of an existing member's interest (the money goes to that member) or contribute cash, property or services to the company (the money goes to the LLC). The choice changes the tax result, described below, and the new percentages for everyone.
4. Amend the operating agreement. Most companies sign an amended and restated agreement listing every member, contribution and percentage, with the voting and buyout rules a two-owner company needs. The new member signs it too.
5. Update the state record if it lists members. Many states do not list members at all. Where the articles or the annual report name the members or managers, file an articles amendment or update the next report, and pay the state's fee for it.
6. Handle the tax change. A one-owner LLC becomes a partnership the moment it has a second member, as the next section explains. An LLC that already has several members stays a partnership.
7. Update banks and records. Banks want the amended agreement to add a signer. If the person who controls the LLC changes, the IRS asks for Form 8822-B within 60 days. Keep the consent, the agreement and any purchase papers with the company's records.

What adding a member changes at the IRS

A single-member LLC is disregarded for income tax: its profit goes on the owner's Schedule C. When it acquires a second member, IRS Publication 3402 says it becomes a partnership under the default rules (unless it had elected corporate taxation, in which case it stays a corporation). From the date of the change, the LLC files Form 1065 and issues K-1s, so the first partnership return covers the part of the year after the new member joined, and the original owner's return covers the months before.

How the member comes in matters too. In the IRS's examples, a buyer who purchases half of the owner's interest gives the owner a taxable sale of part of the business, while a new member who contributes cash to the company for a half interest generally creates no gain or loss for either side.

The partnership also files under an EIN of its own. The IRS's EIN instructions tell a disregarded LLC that applies because it acquired additional owners and became a partnership to apply as a partnership, and the IRS's general rule is that a new EIN is needed when ownership or structure changes. An LLC that was using its owner's Social Security number has no number to file the 1065 under, and one that already had an EIN as a single-member company may need a new one; a CPA can confirm which applies.

A new LLC formed with two or more members from day one skips this: it applies for its EIN as a partnership after the state approves the formation (more at llc-ein.com).

Transferring or selling a membership interest

In an LLC that already has several members, one member selling to another, or to an outsider, is a change of ownership inside the same partnership. The IRS lists "a change in ownership that does not result in the termination of the partnership" among the changes that need no new EIN, and the technical termination that once ended a partnership when half its interests changed hands within 12 months was repealed for tax years beginning after 2017. The LLC keeps filing Form 1065, with the change shown on that year's K-1s; the selling member reports their own gain or loss.

A partnership ends for tax purposes when none of its business is carried on by any of its partners in a partnership. That happens if the LLC drops to one member: it becomes a disregarded entity again, and the IRS lists taking over a partnership to operate as a sole proprietor among the changes that need a new EIN. The final Form 1065 covers the year up to that date.

Under state law, the sale itself follows the operating agreement. Many states' default rules let a member transfer the right to receive distributions without the buyer becoming a member with a vote, unless the other members admit them. That is why a clear transfer and buyout clause matters: it sets who may buy, at what price and with whose approval, before anyone needs it. A transfer document, an amended agreement and, where the state lists members, an update to the state record complete the change.