Adding a member to your LLC is not just paperwork. When you create a multimember LLC or add another owner to an existing LLC, ownership percentages, voting rights, management, and federal taxes can all be affected. Understanding those changes before you add an owner can help you avoid surprises later.
In our previous article, we explained how a single-member LLC works. But what changes when an LLC has more than one owner, or when you decide to add another person to an existing LLC?
A multimember LLC has two or more owners, called members. When another person becomes a member, that person receives an ownership interest in the business. That change can affect profits, decision-making, management, and federal tax treatment.
What Changes When an LLC Has More Than One Owner?
With a single-member LLC, one person owns the entire company. With a multimember LLC, ownership is divided between two or more people. The percentages do not have to be equal. Two members could own the company 50/50, for example, or one could own 70% while the other owns 30%.
Ownership Percentages and Membership Interests
An LLC owner’s share of the company is generally called a membership interest or ownership interest rather than shares, which are more commonly associated with corporations. Members should clearly understand how much of the company each person owns and what rights come with that ownership.
Adding a member therefore means more than putting another person’s name on the business. You are giving that person an ownership interest, which can have long-term business, financial, tax, and legal consequences.
Who Gets to Make Decisions?
Once an LLC has more than one owner, an important question becomes: Who gets to make the decisions?
Understanding Voting Rights
Florida law provides default voting rules when the LLC’s governing documents do not provide otherwise. In a member-managed Florida LLC, a member’s voting power is generally proportional to that member’s percentage or other interest in the company’s profits. An operating agreement can establish important rules governing the members’ relationship and the operation of the business.
This becomes especially important with a 50/50 multimember LLC. Equal ownership may sound fair, but what happens when the two owners completely disagree about an important business decision? Without clear rules for handling disagreements, the owners can reach a deadlock.
For that reason, ownership percentages and voting rights should be considered carefully when creating a multimember LLC.
Member-Managed vs. Manager-Managed Multimember LLCs
Another decision is how the multimember LLC will be managed. A multimember LLC can generally be member-managed or manager-managed.
In a member-managed LLC, the members participate in managing the company. In a manager-managed LLC, management authority is given to one or more designated managers. In Florida, an LLC is member-managed by default unless its operating agreement or Articles of Organization expressly provide for manager management.
For example, three people might own a multimember LLC but decide that only one of them will handle the company’s day-to-day management. Ownership and management authority do not always have to work the same way.
Why Is an Operating Agreement Important?
An operating agreement can be thought of as the rulebook for the multimember LLC. It becomes especially important when more than one person’s money, ownership, and decision-making authority are involved.
Key Provisions for Multimember LLCs
An operating agreement can address the relationship among the members, management of the company, and how the company’s activities will be conducted. Depending on the business, the members may also want provisions addressing ownership interests, voting, and management responsibilities.
It can also address adding new members, transferring an ownership interest, and what happens when an owner wants to leave the company. Owners who need customized provisions or legal advice about their individual rights should consider consulting a qualified business attorney.
What Happens to the Taxes?
This is one of the biggest differences between a single-member and multimember LLC.
Default Federal Tax Classification
For federal income-tax purposes, the IRS generally disregards a domestic LLC with one owner unless the LLC elects another available tax classification. When a domestic LLC has two or more owners, the IRS generally classifies it as a partnership unless the LLC elects another available tax classification.
You do not need to understand every business tax form before forming a multimember LLC. The important point is that adding another owner can change the LLC’s federal tax filing requirements. It is better to consider those consequences before adding a member than to discover the change when it is time to file taxes.
A multimember LLC may also qualify to elect S corporation tax treatment. That election can change how the business and its owners are taxed. Whether it makes sense depends on the business’s income, ownership, payroll needs, and individual circumstances.
PennySmart Group can help business owners evaluate available federal tax classifications and understand the tax implications of each option.
Converting a Single-Member LLC to a Multimember LLC
Suppose Maria owns 100% of Maria’s Cleaning Services LLC. Later, she decides to give Carlos a 50% interest in the company. Maria has not simply added Carlos’s name to the LLC. Carlos has become a co-owner, and the company has changed from a single-member to a multimember LLC.
Carlos now has an ownership interest in the business. The members need to consider voting rights, management authority, how profits will be divided, and what happens if one of them eventually wants to leave.
There can also be federal tax consequences because the LLC has changed from one owner to multiple owners. Adding or removing an owner should therefore be considered carefully before the change is made.
What If the Other Owner Is Your Spouse?
Married couples have an additional issue to consider. Simply because your spouse helps with your business does not necessarily mean your spouse must become an owner of your LLC.
The IRS provides a special federal tax option called a Qualified Joint Venture for certain businesses that married couples own and operate together. Qualifying spouses may divide the business activity between themselves for federal tax purposes instead of filing as a partnership. However, the IRS generally does not allow this option when the couple operates the business through an LLC or another entity created under state law.
Special rules apply to married couples in community-property states. Florida is not a community-property state. As a result, the IRS generally classifies a Florida LLC owned by both spouses as a multimember LLC for federal tax purposes unless the LLC elects another available tax classification.
Working in the business and owning the business are not the same thing. Before adding a spouse as an LLC member, it is important to understand how that decision may affect the company’s federal tax treatment.
When Should You Consider an Attorney?
Not every LLC formation requires an attorney. However, owners should consider an attorney when they need a customized operating agreement or face complicated questions involving ownership rights, unequal voting arrangements, transfers or sales of ownership interests, buyout provisions, significant assets, or disputes between members.
PennySmart Group can assist with the multimember LLC formation process and the tax side of structuring the business. When owners need individualized legal advice or customized agreements establishing their rights against one another, a qualified business attorney may also need to be involved.
How PennySmart Group Can Help With Your Multimember LLC
Setting up a multimember LLC involves more than registering a business with the state. The number of owners can affect the company’s federal tax treatment, and decisions made when the business is formed can affect its tax obligations going forward.
PennySmart Group can assist with forming single-member and multimember LLCs, obtaining an EIN when needed, helping business owners evaluate an appropriate federal tax classification, and understanding the potential tax consequences of adding or removing a member from an existing LLC.
If you are starting a business with a spouse, family member, friend, or business partner, it is better to understand the tax implications before establishing the ownership structure.
Learn How to Register a Business in Florida
The Bottom Line
The difference between a single-member and multimember LLC goes beyond the number of owners. Once another person becomes a member, you need to think about who owns what, who gets to make decisions, how the business will be managed, what happens if the owners disagree, and how the ownership change affects the company’s taxes.
A multimember LLC can be an effective way for two or more people to own a business together, but the ownership arrangement should be considered carefully from the beginning. Clear expectations about ownership, voting, management, and taxes can help prevent problems later.
Thinking about forming a multimember LLC or adding another owner to your existing LLC? Contact PennySmart Group to schedule a consultation. We can assist with the LLC formation process and help you evaluate an appropriate federal tax classification for your business. Contact Us Today!
Reliable Resources
• IRS — LLC Filing as a Corporation or Partnership
• IRS — Married Couples in Business
• Florida Statutes § 605.0407 — Management of LLCs
• Florida Statutes § 605.04073 — Voting Rights
• Florida Statutes § 605.0105 — Operating Agreements
Disclaimer
This article is provided for general educational and tax-information purposes only and is not legal advice. PennySmart Group provides tax preparation, tax-related business assistance, and LLC formation assistance but does not provide legal advice or prepare customized legal agreements. LLC ownership rights, voting provisions, management authority, liability protection, and operating agreements may involve legal issues governed by state law. When legal advice or customized legal documents are needed, you should consult a qualified attorney. Tax treatment depends on the facts and circumstances of each business and applicable federal and state tax laws.