Real Estate Investing

Multi-Member LLCs: Are they right for your business?

Casey

October 25, 2022

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https://www.getaway.co/articles/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:

  • The definition of a multiple-member LLC
  • Difference between MMLLC and other business structures
  • Pros and cons of multi-member LLCs
  • How to form an MMLLC
  • How taxes work for your business
  • How to pay yourself if you’re in a multi-member LLC

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. 

What is an LLC?

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. 

What is a multiple-member LLC?

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. 

What is the difference between single and multi-member LLC?

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.

What’s the difference between a multi-member LLC and a general partnership?

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. 

What are the benefits of a multi-member LLC?

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:

  • You can have as many members as you want.
  • Individuals, corporations, or LLCs can all be members of a multi-member LLC.
  • You don’t have to be a U.S. citizen to be a member.
  • You don’t pay a corporate tax. Multi-member LLCs are classified as “pass-through” entities. That means income is passed through to the owners, and then owners are taxed on the money they earn. 

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. 

What are the drawbacks of a multi-member LLC?

The most significant disadvantage to multi-member LLCs is they are not foolproof. You can still be held personally responsible for a few reasons:

  • You misuse company money.
  • If you cause harm to others or it is illegal. 
  • Committing fraud which includes lying or misrepresenting your company. 
  • Keeping poor financial records.

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 must register with the state.
  • You will have to complete a more complicated tax process, including a self-employment tax.
  • You’re not allowed to classify yourself as an employee (that’s reserved for corporations), so you lose out on some benefits.
  • Every state has a different process for LLC registration. 

Basic Steps 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. 

Choose a business name

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. 

Apply for an EIN with the IRS

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. 

File with your secretary of state

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:

  • Business name
  • Business address
  • Names of owners
  • Type of business

Every state will have different requirements on these forms. So you may see some variation here. 

Create an LLC operating agreement

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.

Apply for permits and business licenses

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.

Open a business bank account

Keep your business separate from your personal expenses. It will help keep your liability protection more intact. 

How are multi-member LLCs and their owners taxed?

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:

  • Form 1065 Return of Partnership Income: This tells the IRS the annual profit and losses of your multi-member LLC. The business fills this form out. 
  • Schedule K-1: Each member fills out this form. The Schedule K-1 form indicates how much of the profits or losses is yours. 

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. 

How do I pay myself from a multi-member LLC?

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. 

How can a multi-member LLC help with your rental property investing?

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. 

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