According to the IRS, Limited liability companies (LLCs) with more than one member default to being taxed as partnerships. This is contrary to a single member LLC, which defaults to a disregarded entity – meaning that it will be taxed a sole proprietorship unless elected otherwise.
Also a multi-member LLC can also elect s corporation taxation, assuming all members qualify. Multi-member LLCs can elect to be taxed as corporations by filing form 8832.
Disclaimer: The information presented in this article is only a basic introduction to partnership taxes. We strongly recommend that you hire a professional to help you. The information provided here does not replace the IRS instructions for filing taxes. Incorrect filings could lead to large tax bills and penalties. Please consider hiring a CPA or an EA to prepare and file your tax returns.
Multi-member LLC taxed as a partnership
When a state organized entity is treated as a partnership for tax purposes, there is usually no tax due to the partnership itself. Instead, income and other tax attributes “pass through” to the partners according to share.
However, partnerships must file their own income tax return each year, to include a Schedule K1 for each partner.
The K1 schedule “instructs” each partner (and informs the IRS) on how much income and other items are to be passed on from the partnership to the individual.
Multi member LLC partnership taxation example
Let’s say that four consultants get together and start a consulting firm.
They form a multi member LLC with the four members. They have not filed any specific elections, so the taxation of the entity defaults to partnership taxation.
The partnership’s four members divide shares of the profits by 25%, 25%, 25%, and 25% among it’s members according to a business plan that they all came up with and agreed upon.
Let’s also assume for our example that the partnership makes $100,000 in net profit from consulting services sales (after expenses).
As required, the partnership files a form 1065 “Annual Partnership Income Tax Return”. Note that they also may need a state income tax return and other annual reports.
Form K1s are filed along with the partnership tax return to report to the IRS the amount of profit that is being allocated to each partner. The partners are each supposed to be provided with a copy of their K1 as well so they know exactly how to report their share of the activity on their personal tax returns.
As previously mentioned, the partnership itself does not pay any tax, but instead the partners have $25,000 each (in this case) to report as income on their personal tax returns.
Common errors with multi-member LLC filings
Many LLC organizers do not realize that they have an additional filing requirement when an LLC has more than one member, and the failure to file form 1065 (US Return of Partnership Income) can result in large penalties.
So be aware of this filing requirement for multi-member LLCs!
Another mistake that newly formed partnerships sometimes make is that they miss the specific due date of this filing requirement. Unlike 1040 (individual) tax returns, the partnership tax return is due on the 15th of March (for calendar year partnerships). This is a month earlier than as with most income tax return due dates. Fiscal year partnerships have different due dates.
In addition to the federal filing, many states require that an income tax return for your multi-member LLC is filed with the state as well.
If your partnership operates in more than one state, there may be several state income tax filing requirements which might include a multi-state apportionment. This is pretty complicated so it’s a good idea to seek advice form a professional if this applies to your LLC.
Please note that there may also be state registration and annual report requirements in addition to the required income tax returns.