Fact checked for accuracy by Billie Anne Grigg, a bookkeeper and Mastery Level Certified Profit First Professional.

If you’re setting up your business with partners, then you might experience confusion about which type of entity works best for that situation.

You’re not alone. Many business owners struggle at first to choose between a C corporation, S corporation, or a multi-member LLC (limited liability company).

This article will cover the advantages and disadvantages of multi-member LLCs, as well as how they differ from single-member LLCs. 

What is a multi-member LLC? Let’s find out.

What is a Multi-Member LLC?

A multi-member LLC is a business structure that’s designed for more than one owner. It’s usually the correct choice when two or more people run a company together and need to create the business and taxation entity designed for that situation. 

Your multi-member LLC also works to protect the personal assets of each business owner. This means your home, automobiles, investment accounts, and other personal assets stay protected if someone sues your company. If you keep your business and personal affairs separate, you won’t lose those items even as the company itself becomes liable for any wrongdoing. 

You might think of the LLC as a separate person, or entity, that shields you from any possible negative aspects that its actions cause. 

One important distinction to think about is that multiple-owner businesses operate by default as general partnerships. A partnership doesn’t offer protection of the owners’ personal assets. You and your partners need to register as an LLC if you seek this personal asset protection. 

Of course, every state uses different regulations and rules during the LLC formation and ongoing compliance process. You’ll need to check your state’s secretary of state website for full details about how it handles all such procedures. What follows will help you understand the basics of a multi-member LLC and how to use it to your advantage.

Multi-Member LLC vs. Single-Member LLC

Aside from the fact that only one owner exists with a single-member LLC and multiple owners use the multi-member LLC, other differences exist between the two entity types. These differences mainly revolved around the areas of taxation and ownership. 

Taxation Issues

You should understand that LLCs are not tax entities. Instead, an LLC is a legal business structure. Whether or not your company incorporates and the number of members dictates how the government taxes the business. 

Unincorporated Single-Member LLC Taxation

From a tax perspective, LLC taxes get assessed on a single-member LLC in the same way as a sole proprietorship

This means the business profits pass through to the owner’s personal return. The owner adds an IRS schedule to their return, revealing company earnings and expenses, and the IRS taxes the owner based on personal income and self-employment tax rules and rates.

Unincorporated Multi-Member LLC Taxation

If you and your partners use an unincorporated multi-member LLC, then you’ll see that the company’s profits still pass through to your personal returns. 

The IRS taxes the business as it would a general partnership. You’ll probably still need to file a separate LLC tax return. However, the LLC itself won’t pay the income tax because its tax return is effectively an informational return only. 

The LLC’s informational tax return shows the year’s income and expenses for the company. The difference between those two figures becomes the company’s profit. You and the other owners then must report your share of those profits on your personal tax returns. 

You need to base the share of the profits due for each owner on the shares each owner holds in the business. If your company reports a $200,000 profit on its LLC tax return and you share 25% equity in the business with three other owners, then each of your personal returns must report and pay tax on $50,000. 

Incorporated LLC Taxation

Single-member and multi-member LLCs both have the option of incorporating as either a C corporation or an S corporation. 

In those cases, the LLC must submit its own separate tax return. This is not an informational return. Instead, the LLC pays its own taxes on the business profits. The specifics of how this works depends on whether you choose to incorporate as an S corporation (pass-through taxes) or a C corporation, which pays its own taxes.

Ownership Inside a Multi-Member LLC

It might appear obvious, but a single-member LLC can only include one business owner. Typically, this person is the sole individual with investment and ownership responsibilities inside the company. 

A multi-member LLC includes more than one owner, of course. Each member, or owner, might invest different percentages of capital into the business. 

For example, you could set up a multi-member LLC with four owners. The ownership split might include 25% for each member, meaning everyone has an equal share and responsibility in the company. 

Or, you might make your investment stake unequal, where two members invest 25% each, a third member invests 10%, and the fourth member invests the remaining 40% stake in the business.

You can also add members to any LLC, so if you’re interested in learning more about that process check out our guide on how to add LLC members.

Advantages of a Multi-Member LLC

The ability to protect personal assets represents one of the best advantages of choosing to use a multi-member LLC. 

The possibility of a lawsuit exists even when you work hard to run your business in the most ethical manner. If your LLC gets sued, then you and your co-owners won’t find yourselves struggling to maintain ownership of your personal homes or retirement accounts.

Lawsuits aren’t the only threat to personal assets. If your business has trouble paying its debts, then creditors will come calling. The first thing they go after is your assets. 

Using a multi-member LLC, you can keep personal assets safe if you ever find yourself in this unfortunate situation. The only exception to the protection comes into play if you or a partner personally guaranteed a business loan. 

Avoid signing off on personal guarantees because then your personal assets do get exposed to business obligations. 

Other advantages of a multi-member LLC include the following areas.

  • You can include as many members as desired. Running a multi-owner business brings the advantage of combining different skills and talents. Collaborating in this manner typically leads to better ideas that move the company forward in a profitable way. 
  • Your company can decide to get taxed as a C corporation or an S corporation, although this is also true for single-member LLCs.
  • Members of a multi-member LLC can include not only individuals but corporations and other LLCs as well. 
  • Members can also include non-U.S. citizens.

Disadvantages of a Multi-Member LLC

The fact that you’re dealing with other partners is a benefit in that you pool talent and resources. It can also turn into a disadvantage. You might not get your way all the time when it comes to major decisions. You’ll need to compromise personal desires regarding the company’s direction at times. 

Additionally, you open yourself to vulnerabilities of personal assets when partnering with others. The personal asset protection detailed above can go away if any multi-member LLC partner does something to put that advantage at risk. 

For example, you’re legally exposed to the negative consequences if another member does something illegal or causes harm to other people during the course of running the business. 

A partner might misuse company funds that result in tax problems or unpayable business debts. They might commit fraud by continuing to run a business that’s unable to repay debt obligations. 

Fraud can also happen if a member lies on financial documents or misrepresents the company in some way. If the member responsible for keeping meeting minutes or financial records fails to perform, then you and the other members become exposed to personal liability

Other multi-member LLC disadvantages include:

  • You need to deal with more paperwork when tax time rolls around. 
  • Every state requires different types of registration paperwork and annual fees.
  • None of the members can act as company employees unless they alter their tax classification.
  • Each owner must pay self-employment tax on company profits (unless changing to an incorporated tax status).

How Taxes Work as a Multi-Member LLC

We detailed how taxes work similarly or differently between single-member LLCs and multi-member LLCs in a previous section. Let’s now talk more specifically about how taxes work inside a multi-member LLC, especially after deciding to tax your LLC as a C corporation or an S corporation. 

The IRS classifies multi-member LLCs as partnerships by default. Via this default classification, the LLC files an informational tax return. Each member reports their share of the earnings on their personal returns and then pays self-employment taxes. 

A Multi-Member LLC Taxed as a C Corporation

Electing to have the LLC taxed as a C corporation means the LLC files a business tax return and pays taxes on income based upon the current corporate tax rates. 

You and your co-owners might save money at tax time by working your LLC’s tax status in this manner. None of you will need to pay income tax on company earnings on your personal returns, unless there is a distribution of profits from the business. This is usually a good strategy when you think you’ll keep a large amount of profit in the company. 

A Multi-Member LLC Taxed as an S Corporation

Filing as an S corporation gives your LLC pass-through status in a similar fashion to the way a partnership pays its taxes. Profits and losses pass through to each owner’s personal tax return. 

The difference between this strategy and paying taxes as an unincorporated multi-member LLC is that you don’t pay self-employment taxes on profit distributions. The self-employment tax applies only to wages and salaries. 

How to Form a Multi-Member LLC

Follow these guidelines to set up your multi-member LLC. 

Select your business name and then use your secretary of state website to determine if that name is available for use. You should check for any trademarks as well. Free tools like this one exist to help in this area. 

File the articles of organization with your state. You’ll need to include the LLC’s name and address, the names of all members, your business type, and your registered agent’s name and address. Most states require that you designate a registered agent who can receive mail on behalf of the LLC. 

Check with your secretary of state to find out if your type of business requires any permits or licenses. Apply for a free employer identification number (EIN) at the IRS website. You’ll typically need the EIN when hiring employees, opening bank accounts, filing licenses and permits, and other such business activities. 

Create an operating agreement that lays out responsibilities and roles for each member. Lastly, open the LLC’s business bank account. You’re required to maintain separation of personal and business finances. 

The Last Word

A multi-member LLC is one of the most effective entities to use when you need to run a business with partners, desire increased personal asset protection, and want flexibility at tax time. Start the LLC formation process if this entity fits your situation. You can read about our recommendations for the best LLC services to get started.

Filed under: Advice Columns

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