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As your business begins to grow, you may consider taking on a new business partner or investor. You can accomplish this by undergoing the simple process of adding a member to your LLC.
Although the process may seem simple, you should proceed with caution and first consider the tax and business consequences of adding a member.
How to Add a New Member to an LLC
Examine Your Operating Agreement
The first step of the process is to consult your company’s existing Operating Agreement for the rules regarding the process for adding new members. In addition to reviewing the voting procedures, take careful consideration in determining the ownership structure, how profits and losses are distributed and how this will change once the new member is added. Honoring business formalities and diligent record keeping will help you maintain the legal protections afforded by the Limited Liability Company as well as guard against any future internal disputes with your new member.
If you do not have an Operating Agreement in place currently, consider adopting one prior to adding the new LLC member. In most states, if an LLC does not have an operating agreement in place, the rule is that any new member will become an equal partner by default. However, you can stipulate different rules for the terms regarding new LLC members by simply drafting and adopting an LLC operating agreement prior to changing the membership structure. Be sure to check the rules with the Secretary of State. Creating an Operating Agreement is substantially easier when there is only one member making decisions in the LLC.
Understand the Tax Consequences
When your existing LLC changes from single-member to multi-member, you lose the option to be taxed as a sole proprietor. By default, your company will be regarded as a partnership for tax purposes by the IRS once there are multiple members. This means you must decide whether you want your business to be taxed as a corporation or a partnership.
If you want your business to receive corporation tax treatment, you will need to decide whether you want to elect to be taxed as an S-Corp or C-Corp. If you do not want to be taxed as a corporation, then you might be best served using a different method to accomplish your business goals. Either way, you will need to file a form to change your structure designation.
Decide on the Terms
The exact details regarding ownership and management for the new member should be decided and discussed with all existing members. Any change in membership interest or capital contribution of the new member will need to be decided on as well.
Vote & Amend
To cement the decision to add a new member, a formal vote needs to be held among existing members. If you are the sole member, make a note in the business records of your vote regarding the new member’s voting rights, managerial responsibilities, and ownership percentage.
Once the vote has been recorded, you may be required by your state to amend your articles of organization to include the new member. Depending on your state, there may be additional legal formalities. For example, in California, all changes in ownership of an LLC must be reported to the California State Board of Equalization.
If you need to file an amendment, be prepared to furnish the following information: the new member’s name, their ownership percentage, address, and any capital contributions made by them.
If your state does not require a formal amendment to be filed, you should amend your LLC’s operating agreement to reflect the change in membership and keep this for your records.
Make Your Tax Election
Before adding a new member, you may have been doing business under your individual social security number as a single-member LLC. If so, you will need to apply for an employer identification number (EIN) for your business. The easiest and quickest way to apply is online through the IRS website. See our article on how to apply for an EIN.
However, if you already obtained an EIN for your LLC prior to the membership change, you will not need to file for a new number.
If you decide that you want your multi-member LLC to be treated as a corporation, you should file Form 8832 from the IRS to make this election.
Decide on a business structure designation with the IRS: https://www.irs.gov/businesses/small-businesses-self-employed/business-structures