A multi-member LLC is, by default, taxed as a partnership — the entity itself pays no federal income tax, and profit and loss pass through to each member’s personal return via Schedule K-1. That default is only the starting point: the operating agreement and a handful of tax elections determine how that pass-through actually plays out among the members.
Partnership Is the Default, Not the Only Option
A domestic LLC with two or more members is automatically classified as a partnership for federal tax purposes and files Form 1065 unless it affirmatively elects otherwise. To be taxed as a corporation instead, the LLC files Form 8832 (Entity Classification Election); to be taxed specifically as an S-corp, it files Form 2553 directly, which handles the classification change on its own without a separate Form 8832. An election on Form 8832 can be made retroactive up to 75 days before filing, or prospective up to 12 months after — there’s no “current year only” requirement the way there effectively is with the S-corp deadline.
What the Operating Agreement Actually Controls
The operating agreement is where members define profit-and-loss allocation percentages (which don’t have to match ownership percentages, as long as they have “substantial economic effect” under the tax code), management structure, capital contribution requirements, and buyout mechanics if a member leaves. Skipping a real, negotiated operating agreement and relying on a generic template is one of the most common reasons multi-member LLCs end up in disputes — the default state LLC statute fills the gaps, and those defaults are rarely what the members actually intended.
Guaranteed Payments: The Partnership Equivalent of a Salary
Members of a partnership-taxed LLC can’t be paid a W-2 salary the way an S-corp shareholder-employee can — instead, a member who provides services can receive a “guaranteed payment,” a fixed amount paid regardless of the LLC’s profit that year. Guaranteed payments are deductible to the LLC (reducing what flows through to the other members) and taxed as ordinary self-employment income to the recipient, which is a real structural difference worth understanding before assuming an LLC can simply “run payroll” for an active member the way a corporation can.
Capital Accounts Track More Than Just Ownership
Each member’s capital account tracks their contributions, their share of income and loss, and any distributions received — and it’s what determines how much a member can actually receive if the LLC liquidates or a member exits. A member’s allocated losses on paper can exceed what they can actually deduct if their capital account (and at-risk basis) doesn’t support it, which is why membership interest sales and buyouts should be modeled against actual capital account balances, not just the ownership percentage stated in the agreement.
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Related reading: LLC vs. S-Corp vs. C-Corp and Self-Employment Tax and Entity Choice.
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