There are two kinds of LLC: those managed by all of the members equally, and those managed either by one or more members, or by a third party individual or business structure. When you’re trying to determine which one is better for you, the crucial issue to consider is control.
The choice of making your LLC member-managed or manager-managed has no bearing on the LLC’s tax election. It doesn’t matter if you’re planning to elect C or S Corporation taxation, or stick with the default flow-through – the issue is control: WHO can direct the LLC’s daily business.
Member-Managed LLCs
A member-managed LLC is operated equally by all of its members. That means that everyone is expected to share equally in business decisions and the day-to-day operations of the entity. Alternatively, you can select a group of members to become the managing members, and let those members manage by committee.
A member-managed LLC is a great choice if you’re a single owner business, and you don’t anticipate every having people come in as silent, non-participating members. It can also work for a multiple-owner business, again as long as everyone is prepared to participate equally, and you don’t anticipate bringing in non-participating investors.
A member-managed LLC is also a great choice for singles or couples who are using the structure for passive income activities, and who aren’t as concerned about estate-planning and ownership succession as others may be. For a single person with no children, there isn’t really a huge need to create a control transfer mechanism. And for couples, the member-managed entity allows for truly shared control between the spouses. If a spouse is injured or ill and unable to communicate, the other spouse can still continue the LLC’s business.
Manager-Managed LLCs
A manager-managed LLC is a two-level structure. One level provides the management for the LLC (hence the name managers) while the other level is made up of passive members. Essentially you’re creating a de facto limited partnership, without the liability that normally attaches to the general partner. You can have as many managers as you choose, and they can be individuals or other business structures. Managers don’t even have to be members, although in most cases they will be.
It makes sense to operate as a manager-managed LLC if you have a situation where some members are not interested in the hands-on management of the structure, but prefer a more passive role. It’s also great for estate planning. By naming your kids as members, you can bring them into the LLC using IRS gifting allowances, while still retaining control of the LLC.
Special Considerations for Real Estate Professionals
If you claim real estate professional classification on your tax return and have a manager-managed LLC, you must be an active participant in the management and operation of the LLC. That means you’ve got to be named as a manager. In a manager-managed LLC, the members who aren’t also managers are considered passive – just as they would be in a limited partnership. If you make a mistake with your planning here you could set yourself up for an IRS challenge.
On the other hand, you could set up your LLC as a member-managed LLC instead. That way, every member is considered to be actively participating. It’s a great way to strengthen everyone’s argument that they are entitled to deduct all of the available real estate losses.
Can You Change an Existing LLC?
If you have started with one kind of LLC but realize that you really need the other, you can fix it. In most cases, all you will need to do is file an Amendment to the Articles of Organization, noting the change from one to the other, and making any changes to the members or managers listed.
Remember though, that most LLC Operating Agreements require a members vote to make significant changes to the LLC, and this definitely qualifies! So you’ll need to draw up a set of Consent Resolutions and have all of the members sign, or hold a formal meeting and have the members vote on the issue. You’ll also have to change your Operating Agreement to account for the change.
Depending on where your LLC is formed, change can cost a little or a lot. In Arizona and New York, for example, you’ll have to re-publish the Amended Articles in a local newspaper, following the state requirements. That can add a few hundred dollars (in the case of Arizona) all the way up to a few thousand dollars (NY LLC in the 5 boroughs area). So, if at all possible, make sure you plan and set your LLC up properly in the very beginning.
Tags: choosing member or manager LLC • LLCs • manager managed LLC • manager-managed • member managed LLC • member-managed
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On December 7th, 2010 | 6:48 pm
BuffaloLawyer said:
Where do you find the requirement that a New York LLC must re-publish when amending it’s articles of organization to change from member managed to manager managed?
Section 206 of the LLC law of NY states:
“Where, at any time after completion of the six weekly publications required by this subdivision, there is a change to any of the information contained in the copy or notice as published, no further or amended publication or republication shall be required to be made.”
I’m just curious if I’m missing this requirement somewhere else?
On December 10th, 2010 | 9:14 am
Megan Hughes said:
You’re totally right - I misspoke on the New York publication requirement.
Which seems to make the publication requirement even more out-of-date. If you can change every facet of the LLC without having to publicize those changes at all, why publicize the LLC’s formation in the first place - especially if the records are available at the Division of Corporation’s website?
Thanks for pointing that out!
On December 31st, 2011 | 7:55 am
TP Lothe said:
I have a single member LLC. My brother-in-law invested a reasonably big amount for initial set up. Our understanding was for him as investor only (Even though before he had asked if there would be share?). He is okay with this set up. I am looking at adding another member soon…should I change LLC type? in this case should I re-approach the issue of adding my B-I-L as a silent member? thanks!
On January 12th, 2012 | 10:40 am
Megan Hughes said:
Hi TP,
Wow, sorry for the late reply on this. The question for you and your B-I-L is: did he lend money to the company, or has he invested money into the company? If he has sent money to the company, then he isn’t entitled to any ownership. If he invested into the company, then he is entitled to some ownership. How much depends on what you negotiate - you could do a straight percentage of overall value, (i.e., company was worth $100k, he invested $25k and wants a 25% ownership stake).
You don’t necessarily need to change the LLC type - adding Members is permitted without changing your Articles (usually, but some states want you to notify them of changes). But you probably do want to review your documents - especially the Operating Agreement - to make sure it is written for a multi-member LLC.
As soon as you have more than one member, the LLC also has to change how it files taxes. If it’s been reporting on your personal return, you now may need to file a Form 1065 return for the LLC. Check with your tax preparer on that point.
On January 15th, 2012 | 2:11 pm
New LLC Owner said:
My question is if a married person starts an LLC by themselves…..and later becomes incapaciated…does the spouse who isn’t named as a manager or member then have control of the LLC? I’m thinking of starting an LLC as a sole owner but have family member’s that will be working for me….If (heaven forbid) something should ever happen to me I wouldn’t want my absent spouse to come back into everyone’s life and try to take control of something that I started on my own with my family’s help. I know that Arizona has community property laws so is there a way I can own the company myself yet protect my family if something should happen to me?
On January 16th, 2012 | 4:03 pm
Megan Hughes said:
Hi New LLC Owner,
You raise a really good point. When you’re the sole owner of an LLC, and the only Manager of LLC, what happens to your business if something happens to you?
I think the answer is largely going to depend on state law and everyone’s individual situation.
Something I suggest for couples is to have the non-owning spouse be a Manager of the LLC, or at least have them added to the LLC’s bank account as a signer. Then your spouse can at least access the funds in the LLC.
On the other hand, if it’s your baby, and you don’t want your spouse to have regular signing authority over the LLC, you can also prepare a Limited Power of Attorney, one that gives your spouse the right to run the LLC ONLY in the event you can’t speak for yourself. You can put the signed, notarized POA in a drawer, or on record with your attorney or incorporating agent.
You don’t have to just name a spouse, either. A trusted friend, relative, family member and so on, would be just fine here.
Whatever you do, having a back-up plan in place is a great idea. Could a former spouse try to take a run at your business? Sure. How successful he/she would be would depend on a number of things, but any way you look at it, it’s going to be extra headache, emotional upset and financial strain on your family at the worst possible time.
The other worst-case scenario would be the reverse situation - you’re hurt, unable to talk, and no-one in your family can either take over the business or access any of the money in the business’s account. Banks are very conservative, and it may take a court order before someone could cash a check for you … more trouble, more upset, more money spent.