In Part A we covered a Single Member LLC. This part will be about a Multi-Member LLC (MMLLC) and this part is more complicated than Part A. 

  Disclaimer: This discussion is incomplete. It does not cover all situations and scenarios. This article is providing information and that information is not intended to be applied to a specific tax situation, but instead to help you some ideas on what to research and evaluate. The article does not provide everything you need to know. 

First thing to know is that a multi-member LLC defaults to a partnership. This means an additional tax filing, a partnership tax return (Form 1065) at the federal level. Typically there are additional state filing requirements. This means additional tax prep fees in addition to whatever costs you have for forming and maintaining the LLC. While these costs can be a tax deduction, realize that you tend to spend more money than you have in tax savings from those costs. 

Also know that the IRS doesn’t say a MMLLC has to exist for a partnership to exist. They may view a partnership as existing even if you haven’t formed anything officially at the state level. This is the IRS definition of a partnership:  “A partnership is the relationship between two or more people to do trade or business. Each person contributes money, property, labor or skill, and shares in the profits and losses of the business.”

Also note that a partnership (or a MMLLC) being in existence does not usually change the nature of the activity for the individual partner. If the activity would be passive income without the partnership, usually, it is still passive income with the partnership in existence. Note the use of the word “usually”. 

If you have a partner or partners in a business activity or a rental activity it may certainly make sense from a legal perspective to establish a multi member LLC. I won’t discuss that. I recommend speaking to a knowledgeable lawyer on the legal aspects. 

Normally partnerships don’t pay income taxes directly. Instead, they pass income, losses, and tax liability to the partners and that stuff is included on the personal tax returns. Generally speaking, a multi-member LLC vs operating without one – when permitted- doesn’t change what deductions are available for you besides the costs of the setting up and operation of the LLC and partnership. One notable exception is if you are in the tax situation in which if the partnership pays the state and any local taxes on your behalf and then the partnership takes a deduction for it. As a partner your share of that deduction might lower your tax liability a little, when otherwise you might not get a tax deduction. That might be beneficial if you aren’t able to itemize on your personal return or if you are limited by the state and local tax deduction maximum. 

In some states and localities having a MMLLC might expose you to additional taxes. This is very situational. 

For most business situations if you have a partner (or partners) and you’ve created a partnership, then you have to file an entity tax return. And if you have a MMLLC, then you have a partnership. An exception may be for some married couples and in some specific cases in real estate. 

The specific cases I mention with real estate are if the owners, married or not, are joint tenants in common, then with no MMLLC involved the owners may be able to file on their separate tax returns on their own schedule Es, splitting income and expenses appropriately. However, make sure that situation is set up properly and ensure it is qualifying ideally before the arrangements are set up (starting points: Rev. Proc. 2002-22 and Regs. Sec. 301.7701-1(a)(2)). Also note that having a MMLLC and a formal partnership arrangement makes a whole lot of sense when working with individuals to which you are not married. 

 

Married situations where the only two partners are married to each other. 

If you are married and operating a small business with a spouse as an active partner in the business, often you may be able to do without a multi member LLC and filing a partnership return by instead treating the activity as Qualified Joint Venture (QJV). Essentially this means you split the income and deductions and file two schedule C forms, one for each spouse. You can find more information on QJVs here. In a similar scenario, a farm might also be a QJV. 

Spouses can generally report the rental activities on schedules E, without having a partnership, unless they have a MMLLC.

If for the rental real estate activity or business activity there is a MMLLC with the married partners and the 2 married partners (married to each other) as the only partners, then a partnership tax return has to be filed UNLESS we are talking about a marriage and partner situation in a community property state. Then the couple may be able to elect to file as if they were operating a disregarded entity (a single member LLC).

I do hope you find this information helpful. I do hope you noted the use of words like “generally” and “may” and “often”. It is possible that your specific situation does not match up to what we present here.