Adding a Member to a Single Member LLC

How Converting to a Multi-Member LLC Changes Things

A single member LLC is a limited liability company with just one owner. This provides simplicity in management and tax filing. However, there are good reasons to add a member and become a multi-member LLC, such as:

• Gaining a business partner to share responsibility and workload
• Bringing in additional capital and resources
• Rewarding a valuable employee with an ownership stake

When the change is made to a multi-member LLC, several things are impacted:

• Ownership is now divided between multiple members based on membership interest percentages. Profits, losses, and control are shared.
• Management structure may evolve if members take on defined roles. Decision-making becomes more complex with multiple viewpoints.
• Tax filing shifts from Schedule C individual returns to partnership returns on Form 1065. This increases complexity.
• Liability protection remains intact but relies more heavily on following formal governance processes.

While these implications should be understood, none are barriers to adding a member. With proper planning, a multi-member LLC can benefit from the blended strengths of its owners.

Reviewing the Operating Agreement

The operating agreement establishes the ground rules for an LLC and outlines important processes and policies. Reviewing this document is the first step to understand requirements for adding a member:

• Does the operating agreement allow for new members? What are the processes and approval requirements?
• How are new membership interests issued and valued?
• What is the impact on profit/loss distributions and voting structures?

If these details are not clearly defined, then the operating agreement may need revised to accommodate the new multi-member structure. Consulting an attorney can help ensure this is done properly.

Holding a New Member Vote

For existing multi-member LLCs, adding a new co-owner will likely require a formal vote. The operating agreement should spell out voting procedures, such as:

• Percentage of votes required – Some operating agreements only require a simple majority, while others mandate unanimous consent.
• Quorum – The minimum number of members that must participate for a vote to be valid.
• Proxies – Rules for one member representing the vote of an absent member.

The actual vote should be documented in formal meeting minutes. This creates a clear record showing the admission of the new member was done properly.

Updating the Articles of Organization

With the addition of a new member, the LLC will need to submit updated articles of organization to the state. Some key items to address:

• Provide the new member’s identifying details – name, address, etc.
• State the effective date of the membership change.
• Indicate if there are changes to the registered agent or principal place of business.
• Pay required state fees to process the changes.

The articles of organization act as the LLC’s charter document and must include current ownership information. Failure to update this after adding a new member could put the liability protection at risk.

Issuing Membership Interests

Membership interests represent an ownership percentage in the LLC. When admitting a new co-owner, membership interests must be redistributed accordingly.

Several factors go into valuing and allocating membership interests, such as:

• Capital contributions – The amount invested by each member.
• Services and expertise – Experience and skills members bring to the business.
• Percentage of ownership – How much of the LLC each member controls.

There are two primary ways to handle the issuance of new membership interests:

1. Existing members sell a % of their interest – This directly reduces their ownership stake in the business.
2. New membership interests are issued – This dilutes existing ownership indirectly as a % of the total.

The process should follow the protocols in the operating agreement and be documented thoroughly. This maintains clear records of ownership changes.

Revising Profit/Loss Distribution

As a new member takes on a percentage of ownership in the LLC, they also gain entitlement to their share of the profits and losses.

The operating agreement should define the distribution structure, which often aligns with percentage ownership interests. For example:

• Member A owns 50% of the LLC and gets 50% of distributions.
• Member B owns 25% of the LLC and gets 25% of distributions.

If the operating agreement lacks sufficient detail in this area, the profit and loss distribution should be amended as part of the process of admitting the new co-owner.

Filing a New Tax Election

From a tax perspective, single member LLCs default to sole proprietorships or disregarded entities. But with the addition of a new co-owner, the IRS automatically re-classifies the LLC as a partnership.

This requires filing paperwork to officially make the tax election change to partnership status:

• Form 8832 – Used for domestic LLCs to elect how they’ll be taxed.
• Form 2553 – Allows an LLC to choose to be taxed as an S-corp instead of a partnership.

Along with the tax election, the LLC may need to change its accounting methods. Partnerships can use cash basis but accrual is typically required.

Consulting a tax professional is wise to ensure compliance with the new multi-member structure.

Issuing a New EIN

Adding members to an existing LLC does not necessarily require getting a new EIN or tax ID number from the IRS. As long as at least one member from the original LLC remains, the EIN can stay the same.

However, it is recommended to obtain a new EIN when membership changes significantly, such as:

• Completely new members taking over the LLC.
• Old members transferring interests exceeding 50% of the LLC.

Updating the EIN provides a clear demarcation between different phases of the business. This simplifies banking, licensing, and tax filing under the new structure.

Updating Business Licenses

Most LLCs need certain state and local licenses to operate legally. As ownership changes occur, these business licenses may need refreshed with updated information.

Check for any licenses tied directly to the business owners’ names or details. For example:

• Liquor licenses – Often restrict transfer without approval
• Professional licenses – Require certain degree-holders to manage

Changing any names, addresses, or contact points on file with licensing agencies keeps everything current and compliant.

Reevaluating Insurance Needs

Bringing new members into an LLC can introduce different risks that may require insurance coverage adjustments. It’s smart to review existing policies and account for changes like:

• Higher revenue projections.
• Expanded services or products.
• New physical business locations.
• More employees on payroll.
• Hired contractors.

Increased liability risks may call for higher insurance limits or new types of policies. For example, worker’s comp, commercial auto, or E&O coverage.

An insurance agent or broker can assess the new LLC structure and build a protection plan tailored specifically for it.

Review Banking and Financing

As a new member comes on board, they should be granted access to the LLC’s banking and financing accounts. This allows appropriate oversight and control of funds.

Key steps include:

• Adding authorized signers to business bank accounts.
• Issuing company credit cards in new members’ names.
• Granting account access to financing platforms.
• Making them jointly liable for any company debt obligations.

Some lenders may require confirmation that the addition of new members does not violate any financing terms or collateral agreements.

Formalizing Member Changes in Writing

While the articles of organization and operating agreement are amended to reflect new members, further documentation is recommended. This provides a paper trail demonstrating compliance.

Helpful documents include:

• Membership ledger – Tracks ownership interests and transfers. Should be updated upon admitting new members.
• Membership certificates – These documents can formally state each member’s rights, interests, and number of units held. Certificates should be re-issued to all members under the new structure.
• Written member consent – Having existing and new members sign a document consenting to the changes adds a layer of legal protection.

Thorough documentation avoids any disputes down the road about applicable dates, ownership interests, rights of members, etc.

Understanding Tax Implications

Beyond filing a new partnership tax return and selecting a tax election, here are other tax impacts to note when adding a member:

• Members may be subject to self-employment taxes on their share of LLC profits.
• Losses and deductions pass through to members to include on personal returns.
• Multiple ownership creates complexity in partner basis, capital accounts, and earnings allocations for taxes.
• Detailed records like capital accounts and K-1s are vital for supporting tax filings.
• Ongoing profit distributions are considered ordinary income.

Consulting a tax professional helps ensure full compliance and proper filing. It’s better to be aware of tax implications upfront when making the change to a multi-member structure.

Is a Multi-Member LLC Better Than Single Member?

There are pros and cons to both single and multi-member LLCs. Factors to consider:

Single Member LLC Advantages

• Simpler governance without compromising with other partners.
• Taxation is straightforward.
• All profits go to the sole owner.
• Decision making is fast and unilateral.

Multi-Member LLC Advantages

• Ability to raise capital and finance growth.
• Owners can blend complementary skill sets.
• Shared management burdens.
• Providing ownership incentives to key team members.
• Perpetual existence beyond sole owner lifetime.

There is no definitively superior option. Business owners should weigh these key differences when deciding if welcoming new members makes sense for their specific goals and priorities.

Steps to Admit New Members

Follow these key steps to smoothly transition to a multi-member LLC:

1. Review operating agreement – Understand the requirements and processes for adding members. Revise the operating agreement if needed.

2. Hold member vote – If required, hold a vote of existing members to approve admitting the new member.

3. Update articles of organization – Submit changes to the state to add members.

4. Issue membership interests – Redistribute membership interests to reflect new ownership percentages.

5. Amend profit/loss distribution – Align distribution of profits/losses with new ownership structure.

6. File new tax election – Elect partnership taxation or S-corp status.

7. Obtain new EIN (optional) – Not required but can help track entity changes.

8. Adjust business licenses – Update any licenses tied to owners’ details.

9. Review insurance needs – Consider changes to existing policies to address new risks.

10. Update banking/financing – Give new members access to accounts and ownership of debt obligations.

Following proper procedures ensures the transition goes smoothly while maintaining compliance and liability protection.

Maintaining Formalities as a Multi-Member LLC

Once established as a multi-member entity, certain practices should be followed consistently:

• Document all major business decisions in formal meeting minutes.
• Adhere to operating agreement protocols for member votes, admitting new members, distributions, etc.
• Keep ownership interests, member capital accounts, and distributions current.
• Hold and record annual member meetings.
• Be meticulous in separating personal vs company finances.
• Renew required business licenses and permits on time.

While multi-member structures add complexity, formal business practices preserve the liability shield and legitimacy of the LLC.

Conclusion

Converting from a single to multi-member LLC brings extra work and complexities. But the benefits of added resources and a broader ownership team often make it worthwhile for established businesses ready to scale to the next level. Adding a member to a single-member LLC involves updating the operating agreement, filing articles of amendment, and transferring ownership. It’s important to consult with a professional and follow the procedures outlined in your operating agreement to ensure that the sale is structured in a way that is beneficial to both parties. Before admitting a new member, it’s wise to consult with a business attorney or another small business professional to understand the legal, financial, and tax implications of adding a member to your LLC.