Ep. 39 | Multi-Member LLC Basics
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Speaker 2:Welcome back to the podcast, everybody. Today, we're gonna jump directly into episode 39. We're gonna look at multi member LLC basics. So before you go ahead and listen to this one, if you haven't had the opportunity to go all the way back to episode two that we posted, I believe was right before Halloween of last year, so 02/2022, We discussed single member LLCs, which actually was one of our top episodes we've ever had. We constantly give good feedback on that.
Speaker 2:People asking questions related to that. Great feedback on the show. So now we're gonna jump into multi members. So again, before you do that, go back and listen to the others. It's a great comparison between the single member and the multi member.
Speaker 2:Some similarities, some differences. We'll leave that to you to make that comparison besides listening to the show. But But before we do that, let's take a moment, thank our sponsor.
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Speaker 3:You can look in our show notes or email us at hello@teachingtaxflow.com.
Speaker 2:Hey, everybody. Welcome back to Teaching Tax Flow, the podcast. Super excited about this one as always. So looking back a bit in some of our earlier episodes, we had a fantastic one that we dove into single member LLCs or just kind of LLCs as a general, a little bit of an intro. Today, we're gonna look at multi members, obviously.
Speaker 2:So as always, again, Chris Pacquero. If you haven't met Chris, congratulations. Stay away from him. He's too smart. He'll make you feel dumb.
Speaker 2:But we'll put him on a little bit of a pedestal. So Chris knows more about any of this stuff than anybody I've ever met, then he's he's probably gonna shut me up here in a second, so I'll just keep rambling. I've known this guy for twenty five plus years, twenty plus years, has given me some of the best advice when it comes to formation, business formation, self employment taxes, etcetera. But multi members, honestly, I don't know a ton about, so I'm gonna learn as much as you guys are in this one specifically. So before we get into it, Chris, how's it going, buddy?
Speaker 2:It is going great.
Speaker 4:I'm just gonna be quiet, and you can keep making me feel good about myself. So thank you. But but then
Speaker 2:you can't get your both head out the door, man. We'll have I'll have to come down there and, you know, deflate a little bit of a little bit of air. That way you can actually get home to your to your family. So I think the best starting point with this is is, obviously, we've talked a lot about single members. Let's talk about these multi member LLC.
Speaker 2:So what exactly is that? Like, what falls within the bucket of a multi member LLC?
Speaker 4:Multi member LLC. Sometimes you feel
Speaker 2:a little confused about that, but all a multi member LLC is is a limited liability company with more than one owner. So it's really it's just as simple as it sounds. Right? There's no I mean, I'm sure there's little exclusions to it, but overall, that's exactly what
Speaker 4:it is. You are correct. Many multi member LLCs are two spouses together. Many of them are just two owners. Some of them have I mean, we in our private tax practice, CPA practice, we have clients that have LLCs with a couple hundred members.
Speaker 4:They're doing real estate syndication or what have you. But any limited liability company with more than one owner, or we would call a member, is a multimember LLC. And just like just like a single member LLC, that multimember LLC can elect to be taxed as a corporation, either a c corp or an s corp. Those are gonna be different episodes, and we dive into those basics. But that's all from a, you know, from an operational standpoint.
Speaker 4:So these are probably very, very common within, all the people
Speaker 2:we know that are REI. So in the real estate investor world, right, I'm sure we see a lot of this. So, like, we always hear about, you know, collection of individuals. One may be a contractor. One may be a really good real estate agent.
Speaker 2:One may be the money guy or gal. So, really, when they come together, obviously, they're probably very simple to create just like a single member. It's very easy to form a multimember LLC. So is that a good example of one where people come together really to the table in a partnership such as that?
Speaker 4:Yes. And a multimember LLC, by default, is gonna file a partnership tax return from the federal tax perspective. The multimember LLC, there's a couple differences between the single and the multi. But from an a legal operational standpoint and, again, we are not lawyers here at Teaching Tax. So we're gonna talk about the tax ramifications of these the multi member LLCs and give you some basics.
Speaker 4:But from a legal standpoint, it's just still an LLC. There just happens to be more than one owner. Typically, on the state side of things, there's not gonna be too much difference when you register the LLC, which is different than the income tax filing. On the federal tax perspective, there are a ton of differences when it comes to having a multi member LLC. Now I'm gonna say one for one caveat out there before we start rolling into some of the basics of a multi member LLC, or we can call it an MMLLC, just to be a little more, concise here.
Speaker 4:There are special rules, these are out on IRS website, for multi member LLCs that are taxed as a single member LLC. These are rare. But if you have a if you are a married couple, you can treat to you could choose to treat your business entity as a partnership or a disregarded entity. So in other words, you don't have to file a federal partnership return if the business entity is wholly owned by the couple as community property under the laws of a state, foreign country, or possession of The United States, no person other than one or both spouses are owners, and the business isn't treated as a corporation. So the bottom line is if you have a married couple that are the only owners of a LLC, and that LLC is community property, in a community property state, then still listen to this podcast because you're gonna wanna hear about it.
Speaker 4:But go listen to the single member LLC podcast and the self employed basics podcast because you would basic you would be a disregarded entity for federal tax purposes. Now
Speaker 2:And without going into too much detail here, Chris, what is what is a community property? Just for Community property is property that is owned in a community property state. Okay. So not every state, obviously, falls into this. There are some that are considered that.
Speaker 2:So if if I remember right in our conversations, there there was about eight or nine of them that were that. Is that correct?
Speaker 4:Correct. And I'm gonna name them because we always have to put California in all of our podcasts. Of course. Then you base and
Speaker 2:and those that are from California, we
Speaker 4:love you. Yes. We we absolutely love you. And, yes, we love poking fun of you. So but that's all.
Speaker 4:Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, Wisconsin, and Alaska is an opt in. If you have a multimemberal LLC, both spouses own the LLC in one of those states, you would you may elect to not be taxed as a partnership for federal tax purposes, which makes your tax reporting much easier. I can believe you can pay for it. LLC. Thank you.
Speaker 2:Thank you for going to that. Sorry to kinda derail us a little bit. Just those were, you know, not too familiar with that. So back to your regulars regularly scheduled program.
Speaker 4:Regularly scheduled pro abs absolutely. We're back.
Speaker 2:A kickback to the LLC. I like that. You know you know, unfortunately, though, it just started to I I'd started to get comfortable with multi member LLC rolling off the tongue, and now we're gonna talk.
Speaker 4:Well, just roll with it then. Yeah. Let's do it.
Speaker 2:Either way, we can call it an m m m two, m squared LLC. Y'all know what we mean. So so jumping at this a little bit, Chris. So, like, when somebody asks you, hey. I'm thinking about forming something.
Speaker 2:Obviously, now we've discussed, you know, really what that looks like. So it's very similar to a single member, obviously, just with multi members. You know, you file a a a partnership form at the end. So what's the next steps? Like, what's your other kind of words of wisdom regarding the m squared LLC?
Speaker 2:When you start the m squared,
Speaker 4:what you have to consider is you have to register in the state. You have to have a registered agent. Then you would figure out then you would obtain a federal identification number. You file a form SS four that file that could be filed online with the IRS, or you have a professional help you. I'd recommend having a professional help you.
Speaker 4:If you need help, please go to defeatingtaxes.com, our private Facebook group. We're happy to give you some resources there. But you'd obtain a federal identification number. When you obtain that federal identification number, the IRS is gonna ask you, how many members do you have? Why?
Speaker 4:Because IRS wants to know, do we expect that you're gonna file a partnership tax return, you know, for this entity? By the way, those returns are due March 15, not April 15, without a valid extension. And if you file the return late, it's 200 per member per month late fee.
Speaker 2:Oh, that's a good that's a good hit for that. Maybe we'll actually put that in the show notes, just a reminder. We'll bold it.
Speaker 4:Well, If you file a multi member LLC, there are a lot of advantages, but you have to consider that the l at that point, you're not disregarded. The LLC itself will file a separate tax return. We're gonna dive into that in a moment and issue what's called a form k one to each member, and that k one form lists each member's share of the profit, the loss, and any other tax related activity for that entity. Could be a credit. Could be a special deduction.
Speaker 4:The cool thing about a multi member LLC, we call it it's, it's your boutique entity because we can form it. We can to have different members receive different deductions, different shares of income, all of that's laid out by your operating agreement. The in my opinion, the most important document in the LLC formation, and all the tax professionals understand that the operating operating agreement is what dictates how we prepare multi member LLC tax returns.
Speaker 2:Now So, really, it's it would be safe to say that a that an m squared LLC is not if you are a DIY person, that you're gonna file your own your own returns, this likely is not the best one to do yourself just because there's a lot of moving parts and a lot of planning that could go into this. Correct?
Speaker 4:You are correct. Put in your mind that it's gonna cost you a decent amount of change each year for state filing registration, for tax preparation, for legal fees, or registered agent fees, or this multi member LLC. That doesn't mean it's not worth it. It's just one of those things that I'll give you an example. Trying to think of a sport that I don't really give a soccer.
Speaker 4:Now I'm a you know, some people are looking upset.
Speaker 2:I thought they were gonna say, like, curling or something. So it's
Speaker 4:all good. Yes. I I I went to an MLS game here in Nashville. I had a great time. If you would have told me I'm in the second row or put me in the second to last row, it wouldn't have changed the time I had.
Speaker 4:Because I was looking at the atmosphere, and it wasn't worth it for me to buy second row tickets. But, if you're talking about my Tennessee Titans, I'm gonna pay more to get as close to the action as I can. The analogy is this, if you're someone that's going to be very have this business do significant amount of income, you have some growth, you have a complicated situation, you have the resources to hire professionals to help you, the multi member LLC might make sense. The biggest thing I see out there is is a challenge, is when people form these LLCs, multi member LLCs, they have significant filing requirements and very little income because, ultimately, the overhead costs of functioning an LLC are the same for someone that's doing $600,000 a year or $6 a year.
Speaker 2:Makes sense. Makes and that's actually really good advice. Similar to, you know, what I hear a lot in my world and habits, you know, hey. A a patent is only as good as how much you wanna put into it to protect it. You know, not not the same, but, you know, it's it's not to set it and forget it.
Speaker 2:There's a lot that goes into it. So a
Speaker 4:multi member LLC, what we're gonna talk about is from a tax perspective, I mentioned this, your default tax classification is a partnership. You would have to elect to be taxed as anything other than that. So let's just focus on the fact that you now, for tax purposes, federal tax purposes, will file as a partnership. And that partnership, like I mentioned before, files an annual return due March 15, and that form is called a form ten sixty five. Now, when we talk about so let's just jump into, you know, the formation management and asset protection.
Speaker 4:I should've jumped into that first, but those are the the pluses. Right? I mean, we're not trying to pooh pooh on multi member LLCs, but we want people to understand the mechanics of the multi member LLC. The difference that between that and maybe a sole proprietor. That's so difficult.
Speaker 2:And really, we talked a we talked a little bit about the formation and management, but, yes, let's let's kinda break it down for everybody here. So like he was mentioned, you know, obviously, asset protection, we'll get into that as well. But, yeah, let's jump into this. So if you were walking somebody through the steps, and I know you've you do a lot of lot of education, a lot of public speaking, a lot of events on this. Let's I'm excited to to hear you go through these.
Speaker 4:Well, so for a month yeah. Multi member LLC, we already had talked about this, but you file your document formation documents with the state that you're going to operate in, not the the IRS is who you file with to get the federal identification number, but these are the formation documents are filed with the state. As I said, owners are referred to as members, and the members have an operating agreement that outlines a management, including ownership percentages, share of profit, and loss. This is the really neat thing about the multi member LLC as opposed to maybe an s corporation or something like that. Like, John and I let's say we form a an LLC.
Speaker 4:John's a lazy bum, and I'm a I'm a grinder, and, we buy a hotdog stand. Alright? And we say, we're gonna split the profits. Okay. Great.
Speaker 4:But I'm upset because I'm the one working the hot dog stand every day, and John's sitting home watching soccer, which we now we know this is really not a true story.
Speaker 2:Hey. R and d taste testing is
Speaker 4:a real job. No. That's true. That's a let's
Speaker 2:be let's be serious. There are a lot of lot goes into that. You know, you gotta train the taste buds. Right?
Speaker 4:Because I'm doing all the work, I might get paid a certain amount of money per day as a guaranteed partner payment, or we might say, look, Chris, you you own 50%, John, you own 50%, but Chris, you're gonna get 80% of the profit in loss. John only gets 20% because I'm doing all the work. That has to get spelled out in the operating agreement. We're talking about the the formation of management asset protection. Now one thing to also consider is when you're contributing to the LLC.
Speaker 4:Let's say John and I had this hot dog stand, and John had a hot dog stand because he's such a lazy bum, it failed, yet he has $5,000 worth of equipment. He might contribute the equipment, and I might contribute $500 of cash, and that's okay, but that gets laid out in the operating agreement. So for except for the receipt of cash, contributing property in exchange for membership interest is a tax free event. So John has that that equipment that he has, It we say it's worth $5,000. He's never depreciated it, and that's a fair market value.
Speaker 4:He contributes that to the LLC for his membership interest. He doesn't have to pay tax. He didn't sell that equipment to the LLC. Now this sounds like a silly example. What happens when there are real real estate assets involved?
Speaker 4:Right? What happens when there's intellectual property? That's why those operating agreements are very important. The life of the LLC is usually limited to a fixed period of time. At least because if one member passes away or one member leaves, now you don't have a multi member LLC anymore.
Speaker 4:And when does this make sense? Well, my opinion is best when owners want liability protection, so asset protection. You're a limited liability company. You wanna avoid double taxation at a c corporation. So the LLC itself from a federal pack tax perspective doesn't pay a federal tax.
Speaker 4:We talked about those k ones going to the the owners, and members don't want to
Speaker 2:be liable for the debts of the LLC. And so, basically, everything everything is to a little bit different from a single member except for that asset protection. So really asset protection is kind of an I wouldn't say a no brainer, but that's really I mean, it's literally in the the name. Right? LLC.
Speaker 4:It's and with LLCs, you can have you can have different levels of membership interest as well. Like, you could be a limited partner or general partner. So it gives you again, it gives you a lot of flexibility. When you think about multi member LLCs, it's a way to formally be flexible with one or more business partners
Speaker 2:in your I need to let you kind of a a lifespan on that, so we'll call it an expiration period. Is there a reasoning behind that that that's in place? It's not just an infinite, formation?
Speaker 4:Well, yeah. I mean, it's gonna yeah. Eventually, it'll it'll end.
Speaker 2:Okay. Right? Because I don't know if they said anything. Bypass that.
Speaker 4:Way or mhmm. It it will end at some point, the the LLC. It could be earlier than you think, but, essentially, all, you know, all good things have to come to an end. Where corporation is a little different where it it goes into perpetuity. The shit Gotcha.
Speaker 4:Corporation or transport. Excellent. I tease this a little bit. Let's let's, you know, to so put everyone at ease here as we as we kinda wind things down. Let's talk about taxation, reporting infringed benefits for a multi member LLC.
Speaker 4:I already mentioned you're avoiding double taxation, so there's no tax paid from a federal perspective on the LLC level. We talked that, you know, you do have to file a form ten sixty five and issue k ones. We'll put those links. Now with that form ten sixty five, you're required to report what's called a balance sheet to the IRS, where if you're self employed, you just slap your income and deductions. You don't have to worry about a balance sheet, meaning what's in the bank at the end of the year, what assets do you have, what's your equity accounts.
Speaker 4:So the comp so with the multi member LLC, double entry bookkeeping is required, and that tax return requires a balance sheet. That kind of is wrapped into those expenses that we talked about of having an LLC. Mhmm. When members come in and come out, you know, it gets pretty complicated with the books and records, especially when members are contributing things that are not, cash. So, John, we had that hot dog stand going where it's going well.
Speaker 4:You've got a buddy that that that had two failed hot dog stands, and he contributes those for now 25% of the business. Those things have to be spelled out in that operating agreement, but it can get very complicated because each member of the LLC has his or her own his or her own equity account. One more thing I wanna mention, an entity can be a member of an LLC. So you could have on a single member LLC that's a member of a multi member LLC.
Speaker 2:That's interesting. No. That's that's definitely news to be there. So
Speaker 4:Mhmm. It was a pitfall. Big pitfall is to as we wrap up taxation, if you're a member of an LLC taxed as a partnership, you should never ever pay yourself in w two wages. Okay. That's it.
Speaker 4:I we've had to undo that. If you're paid a certain salary, those are called guaranteed partner payments. And typically, for general partners, your net income from the LLC is subject to self employment tax. We know that rental property is not. But the positive is is that your members typically qualify for that 20% section one ninety nine a or qualified business income deduction if it's a functional business.
Speaker 4:But if the LLC owns real estate, then that really doesn't typically doesn't play a role. It's final thing I wanna touch on is not uncommon. It's not uncommon for an LLC to have multiple types of businesses in it. So let's so you could have an LLC that owns some rental real estate, but also has some business income involved. You know, let's say you are you buy a building, you operate a, you operate your medical practice from the bottom, and you rent out the top, to someone that lives there.
Speaker 4:So live work. Right? It's a you the l l it's one building. It's one LLC. So you might have some rental income.
Speaker 4:You might have some operational income. Again, you might form a different LLC just for the medical practice and pay yourself rent, but I'm just making you an example. I'm not saying that's a good tax plan. But,
Speaker 2:I need to make a good point too a a moment ago too. So, basically, just to reiterate. So real estate income is not, not eligible. Oh my gosh. I'm I'm drawing a blank on the side of it.
Speaker 2:You you do not get tax self employment tax on any real estate income. That's correct. Right? In most cases.
Speaker 4:No. In most cases. It depends. So if you're a, you know, if you're a house flipper. John, if you go flip one house, you and your lovely wife, you will pay capital gain tax on that, but you will not pay self employment tax.
Speaker 4:But if you become if you get in the business of flipping houses, now you're subject to self employment tax. Gotcha. Okay. Makes sense. The partnership reports things based on, you know, based on those activities.
Speaker 4:So, and I lied. The final thing is, typically, the multi member LLC must use the same tax year, which is December 31, as its partners. Where I'm not you know, to put a bow on this, the multi member LLC is a very, very popular type of entity. There are a lot of advantages to it because it gives us a ton of flexibility. The negative of it is simply the cost of administration.
Speaker 4:And before you jump into forming a multi member LLC, make sure you talk to a professional tax preparer and your attorney. I know that's a disclaimer we always like to use, but it true it's truly is important because I've seen firsthand I I I'm not kidding you. We just had a, someone in our defeating taxes Facebook group reach out to us. They conducted a teaching tax for urgent care session with us, and we discovered almost a hundred thousand dollars of potential penalties, for not filing partnership returns when they should have filed partnership returns back from 02/2018.
Speaker 2:We're looking back and, really, you know, you mentioned that that's a disclaimer that we always toss in. But it's not it's not just a disclaimer for liability. We'll use that term in here. But it's also just to making sure making sure that things are done right and most effectively because this is a a lot more complex. And, you know, as far as for setup maintenance, like you mentioned, you know, your books really gotta be in order.
Speaker 2:There's a lot more requirements on it. Just a lot more planning. I mean, it's always nice to have somebody that's in your corner with you and
Speaker 4:not you know, you're out of your own island. Teaching tax flow community. If you're not a soccer fan, don't spend the money to get second row seats. That's probably the best best way I could put it.
Speaker 2:It's it's a good mic drop moment. So and thank you again, Chris, for for diving into this. I mean, I was jotting down some notes here for myself. You know, as much as I like to think I know about this just from being with y'all over the years and doing this, there obviously, there's a lot of comparisons. There's things to consider, and, you know, I love the I love the, the quote or whoever was the first one to say it, I guess.
Speaker 2:I'm not sure. But, you know, is is the juice really worth the squeeze and making sure that you're going into this with the full understanding. So if you if you've considered this as an option or somebody said, you you need to go create a multimember LLC, go back, listen to this a few times, jot down some of those notes. Any questions, always reach out to us, you know, on on our social media channels there or in the defeating taxes group or email us at hello@teachingtaxflow.com. We'd be happy to answer any questions you guys have.
Speaker 2:But until then, we will see you next week as always. Thank you so much for joining us. John Schopolsky from the teaching tax flow team is still here. Can't get rid of me. Again, I like to hang out for a few at the end.
Speaker 2:Hopefully, you enjoyed this episode. Again, just like all those prior, we had hit some great topics here. Picked Chris's brain a little bit. Did a great job of really comparing the single member and the multi member, but as always, if you have any questions, feel free to reach out. That's what we here at Teaching Tax Flow are for.
Speaker 2:That's why we've built the platform. That's why we continually extrapolate information from Chris Paciro's brain and put it out there into the world for all of you to benefit from. So if you have any of those questions that were not answered in this show, again, always feel free to reach out. As always, I'll go through the punch list. Defeatingtaxes.com is a private Facebook group.
Speaker 2:This is your invite, personal invite. Can't say we didn't invite you to the page. Hopefully, we see you there, if you're not there already. Feel free to send those questions there. Also, feel free to just send us a Facebook message on the Teaching Tax Flow Facebook page if you prefer, or shoot us an email, hello@teachingtaxflow.com.
Speaker 2:So until it as always, everybody, we will see you next week. And you should carefully examine the risk factors and other information contained in the memorandum. The content provided is for educational purposes only. We encourage you to seek personalized investment advice from your financial professional. For all tax and legal advice, please consult your CPA or attorney.
Speaker 2:Investment advisory services are offered through Cabin Advisors, a registered investment advisor. Securities are offered through Cabin Securities, a registered broker dealer.
