Single Member LLC vs Multi Member LLC Taxes

Attorney Thomas B. Burton explains the difference between Single Member LLC and Multi Member LLC Taxes and also explains how the number of members you include in your LLC determines how you file your taxes with the IRS when you choose to file as a disregarded entity.


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Welcome back!


I'm Attorney Thomas Burton. I'm a business law and estate planning attorney here in Wisconsin and today's topic is Single Member LLC versus Multi-member LLC Taxes.


So as we approach the time of year in the spring, when you think about filing your taxes, it's also a good time to revisit the difference between a single member LLC and a multi-member LLC and how that works for the taxes and when I'm meeting with clients to discuss forming a new LLC, which as a reminder is a limited liability company, in Wisconsin, sometimes they will discuss whether they want to have one member or multiple members. Sometimes it's a two-person enterprise or they're considering adding what they might call a business partner. Now for matters of law, they aren't really going to be your partner, they'd be a member of the LLC but let's say, you're considering going into business with a friend or someone else and you're wondering the pros and cons and things like that. Well one thing you want to think about is the taxes. Now I often encourage people, if it's a business they're going to operate, to consider owning it themselves because they maintain 100% control of the business but the other side to think about is if you add a member, how does that change your tax filing options.


So I have put together this video to help walk you through it.


Basically, it's important to understand an LLC is a creature of state statute meaning whatever state you live in, you form the LLC under the laws of that state or you can choose another state but it's going to be formed under state law, the legal entity but then, we get to the IRS level, the federal taxation and they have a couple of options for that.


So on this side I have a single member LLC, that's one person as the member, one two three LLC. By default, the IRS calls it a disregarded entity meaning you have flow through taxation. So you can see here, I have one two three LLC, the profits and losses of the business will flow through to the individual owner's tax return. Generally, on your 1040 as either schedule C business, E supplemental or F for farming. So a lot of folks are going to be on schedule C, if it's a business, filing your profit or loss from the business similar to a sole proprietorship. So when you hear someone say they're a single member LLC taxed as a sole proprietorship, that's what they're talking about. It's looked at exactly the same way by the IRS as a disregarded entity for tax filing.


Now let's move over here to a multi-member LLC, the default in that case is you are looked at as a partnership and you must file a partnership return which is Form 1065 with the IRS. So in this case, the profits and losses from the business are going to flow through, they're going to get reported on Form 1065 which is sent to the IRS. Then the company gives each member a K1 and that K1 reports the members proportionate share of the profits or losses of the business. They receive the K1, then they take the K1 and report that information on their individual tax return and you can see, I ran out of space but there's an extra tax return in the middle here that must be filed form 1065. And let's say, you have a LLC with three members and they each are one-third owners or 34-33-33, that's the percentage of the profits or losses that will flow through to each one, 34-33-33. So what's important to keep in mind, when you're forming your LLC and discuss this with your attorney when deciding, if you're forming a single member LLC, your taxes can be relatively straightforward like a sole proprietorship meaning you don't have to file an extra tax return come tax time, you can file on a schedule to your individual tax return. If however, you're forming as a multi-member LLC, you immediately are going to trigger that requirement to file Form 1065, the partnership tax return and in my experience, most people need to hire someone to help them do this. If you do taxes in your day job, you can probably do it but and some people learn the form but a lot of people hire someone to help. So just think about this in terms of your startup costs and ongoing tax compliance costs. Sometimes, I have people come to me and say they want to add a friend as a minority member, 10% or something like that, they want to maintain control of the business which is always smart, more than 50% in my opinion, if you're the one doing most of the work and you're going to own the business but they say maybe I want to add my friend this five percent and I say that's okay but do you realize that if you do that, you immediately have to file a partnership tax return, you can't file anymore as a simple disregard, you know on your schedule to your own personal tax return.


So here's a highlight - single member LLC, no separate return required. You can claim the profits or losses on schedule C for business to your individual return and this is similar to sole proprietorship. Multi-member LLC meaning more than one, so two is multi-member, must file partnership return, members take their portion of profits and losses, is reported on K1 and then report that information on their individual tax return. So again, it's more than one member is multi-member, it doesn't mean you know, if you're 12 members, you have to file the partnership return but if you're two, you don't.


So think about that side carefully in terms of the tax compliance and it depends on your business, how big a business you're starting, you know, are you a startup software company, are you a startup lawn service company and who's going to be helping you with it.


Now, both entities can choose to be taxed as a corporation and that's another discussion for another day, you should have with your attorney and tax preparer/tax advisor but if you choose, corporate taxation, then you get taxed at the corporate level and then, you would, the shareholders or the members would get a dividend distribution and then they would pay tax on the dividend. So a lot of people don't do that because of you hear about the double taxation but in some industries, you may want that.


So here's the key points - think carefully about adding members and whether it's worth the extra tax compliance cost each year., if you're just getting going and you're keeping a lid on cost. Single member LLC is disregarded entity, is the simplest for tax filing, so if you're already a sole proprietor and you're worried about what happens if I form this LLC, for I know it's a good idea for liability purposes, well you can form one and still file on as a schedule C tax return like a sole proprietor and the final thing I want to mention is for viewers here in Wisconsin, if you're in a community property state, the IRS has a special rule where they will allow a husband and wife to own the LLC as the only members. So they are the only two members but they can still file as a disregarded entity meaning no separate partnership tax return. In Wisconsin, we have marital property which is called community property in most other states, so there's about a handful of states that have community property, California is another one and the IRS has said, if you want to file as a disregarded entity and husband and wife are the only members, you may do so. So that's a big bonus for husband and wife LLC owners in a community property state. Now the IRS says, you can also elect to file as a partnership and they will accept that as well, if you want to do that. So that's a discussion to have with your attorney and tax advisor but just be aware, if you're watching this video, you already have the LLC set up or something and you are a husband and wife member and you're living in Wisconsin, you can still file as a disregarded entity, which is really nice if you file joint tax returns, you can just file as a Schedule C for business to your individual tax return or a single member LLC for a legally married couple in Wisconsin. Now for all the other states, if you're not community property, that doesn't apply. So think carefully about that, that's a special rule by the IRS but in general, think about whether you want to be single member LLC or multi-member LLC and think about the tax side before you make that decision to file, inform the LLC in the articles of organization with the state of Wisconsin because it's important, in my opinion, to have a clear picture of the ongoing tax compliance cost of your LLC and if you watched some of my other videos, you'll know currently in Wisconsin, the annual fee for an LLC is $25, so the ongoing compliance to maintain it is not that expensive, however, paying someone to file your partnership tax return each year likely will be several hundred dollars which is significantly more than the LLC filing fee. So just think about those costs again, if you're a business looking at keeping a lid on costs, a small business, it's important to understand that difference because I've seen some situations where people had no idea that adding a friend or a relative as a five percent member of their LLC, could make a big difference on the tax filing options available to them.


So I hope this video has been helpful to you. I try to make videos on topics I see come up and ones I also think are confusing, can be confusing even to me as an attorney and if you have found this helpful, consider giving it a Like so others can see and benefit from the information as well.


Thanks for watching and we'll see you next time.


© 2021 Burton Law LLC. All Rights Reserved. Transcript and captions provided for ease of access for the hearing impaired. For questions about this topic, or to suggest a topic for a future blog post, please contact the office.