You Brought On a Partner — Here's How Multi-Member LLC Taxes Work in 2026

Two brothers ran their family's Arizona concrete contracting company. Bruce Johnson was paid $4 million in officer compensation over several years. His brother Donald received $7.3 million. The IRS looked at those numbers and decided the pay was unreasonable. They wanted nearly $3 million back.

The Tax Court upheld every dollar. The brothers ran daily operations. They drove dramatic growth. Shareholders still earned healthy returns on equity. Those returns ran about 9 percent in some years. They hit 10 percent in others. (H.W. Johnson, Inc. v. Commissioner, T.C. Memo. 2016-95)

That case was a C corporation, not an LLC. But the lesson lands directly on your multi-member LLC taxes now that you've brought on a partner. When two or more owners share a contracting business, documentation of who does what is what protects you. The IRS argued those salaries were too high. In an S-Corp, they sometimes argue the opposite, that wages are too low. Reasonable means reasonable in both directions. In any multi-member arrangement, I tell clients to put each member's actual role and contribution on paper. It decides compensation questions, and it's the same record that wins disputes.

What changes about my taxes when I add a partner to my LLC?

The single biggest change is that you no longer report business income on a Schedule C attached to your personal return. With two or more members, the IRS automatically classifies your LLC as a partnership for tax purposes. Your business becomes a pass-through entity, so the profit lands on your personal return.

Instead of one Schedule C, the LLC now files its own separate return: Form 1065. That return shows the total income, expenses, and profit for the whole business. The LLC sends each member a K-1 showing their slice of the profit to report. You take your K-1, attach it to your personal Form 1040, and pay tax on your share at your individual rates.

If you want a deeper walk-through of the filing mechanics, I've written a separate guide on how to file taxes for an LLC partnership that covers the Form 1065 process step by step. For first-year filers transitioning from a solo setup, the first-year LLC tax filing guide breaks down what changes and what carries over.

How does self-employment tax work for LLC members?

Every member who actively works in the business pays self-employment tax on their share of the profit. The combined rate for 2026 is 15.3 percent. That breaks down as 12.4 percent for Social Security and 2.9 percent for Medicare.

The Social Security portion stops at the wage base. For 2026, that line is $184,500 (SSA 2026 Fact Sheet). Every dollar of profit above that only carries the 2.9 percent Medicare portion. If your share of the LLC's net profit is $120,000, you pay the full 15.3 percent on all of it because you're under the wage base. If your share is $200,000, you pay 15.3 percent on the first $184,500. You pay 2.9 percent on the remaining $15,500.

This is the same self-employment tax you paid as a sole proprietor. The difference is that now it's calculated on your share of the partnership profit shown on your K-1, not on a Schedule C. For a full breakdown of how the math works, see our guide on self-employment tax for contractors.

How do we split profits between members?

The profit split does not have to match the ownership percentages. This is one of the most useful features of a multi-member LLC, and it trips up contractors who assume the split is locked to ownership.

If you own 60 percent and your partner owns 40 percent, the default is that you report 60 percent of the profit on your K-1 and your partner reports 40 percent. But an LLC operating agreement can specify a different split — called a "special allocation." If one member contributes more labor and the other contributes more capital, you can allocate more profit to the working member.

The IRS requires that special allocations have "substantial economic effect." In plain terms, the allocation has to follow the money. If you say your partner gets 60 percent of the profit but they only contributed a truck and never showed up on a job, the IRS can reallocate the profit to match the actual economics. I've seen contractors get creative here and it works fine when the split reflects what each person actually brings to the business.

Should our multi-member LLC elect S-Corp taxation?

Yes, once the profit justifies the added cost. An S-Corp isn't a different kind of company; it's a tax status you choose. You make the election by filing Form 2553. The LLC still files as a partnership at the state level, but the IRS treats it as an S-Corporation for federal tax purposes.

The benefit is that S-Corp distributions are not subject to self-employment tax. As a partnership, every dollar of profit you take carries the 15.3 percent SE tax. As an S-Corp, you pay yourself a W-2 wage, and the rest comes out as distributions with no SE tax.

My threshold for when this starts making sense: when net profit clears $80,000 to $100,000 and looks repeatable, it's time to run the S-Corp math. Below that, payroll costs, tax-prep fees, and state compliance eat the savings. Above it, the savings grow faster than the fixed costs. For a side-by-side comparison, see our guide on LLC vs S-Corp for contractors.

Every owner who works in the business must take reasonable compensation. In my experience representing contractors in audits, a salary of roughly one-third of net profit is the level that consistently holds up. The rest comes out as distributions. If the LLC nets $150,000 and you and your partner each work full-time, each of you might take $50,000 as W-2 wages and the remaining $50,000 as distributions. The wages carry FICA. The distributions do not.

That H.W. Johnson case I opened with is the cautionary tale in reverse. The IRS argued their pay was too high. In an S-Corp, the IRS sometimes argues your pay is too low. Both directions fail when the salary doesn't match the work. Document what each member does, what the market pays for that role in your trade, and let the salary follow. For more on the timing, see when you should become an S-Corp and our guide on how to pay yourself as a contractor.

How do quarterly taxes work for a multi-member LLC?

Each member pays their own quarterly estimated taxes individually. The LLC itself does not pay income tax, so there is no entity-level estimated tax payment for federal purposes. Each member looks at their K-1 share of the profit, estimates their total tax liability for the year, and makes four payments.

My standing advice to trade contractors: sweep 25 to 30 cents of every net dollar into a separate tax account the day you take the draw. In no-income-tax states, 25 percent covers it. In California, use 30 percent. In an unusually profitable year, push to 35 percent or higher. Always apply that to net, never to gross. For the full quarterly payment mechanics, see our guide on how to pay quarterly taxes as a contractor and our breakdown of how much to set aside for taxes.

One trap catches contractors new to partnerships: the first year you add a partner, you may owe more than you expect because the profit is now flowing through a K-1 rather than a Schedule C. The timing of when the K-1 arrives can also push you past the safe harbor, the payment target that keeps the underpayment penalty from touching you even if you still owe at filing.

Does the QBI deduction apply to multi-member LLCs?

Yes, and it's significant. The QBI deduction shields up to 20 percent of your business profit from income tax, with limits at higher incomes. Each member claims the QBI deduction on their personal return based on their share of the LLC's qualified business income as reported on their K-1.

For 2026, the QBI threshold for married filing jointly is $403,500, and for single filers it's $201,750. Below those thresholds, the full 20 percent deduction applies with no complications. Above them, the deduction begins to phase out and is limited by the greater of two factors: 50 percent of W-2 wages paid by the business, or 25 percent of W-2 wages plus 2.5 percent of the business's qualified property. For a plumbing or HVAC contractor with significant equipment and payroll, the qualified property piece often saves the deduction even when the wage factor alone falls short.

If your multi-member LLC elects S-Corp taxation, the W-2 wages you pay yourselves count toward the QBI wage limit. That's one more reason the S-Corp election can help at higher income levels — the salary you're required to take also feeds the QBI calculation. The OBBBA also added a QBI minimum deduction of $400 for 2026 when you have at least $1,000 of active QBI, so even a small share of profit gets a floor under the deduction.

What about state taxes and franchise fees?

A multi-member LLC files a state partnership return in most states, and each member reports their K-1 share on their personal state return. If you're in California, the state charges a franchise tax, owed even in a year with no profit. California's LLC franchise tax is $800 per year. A multi-member LLC in California files Form 568, and once its California total income reaches $250,000 it owes an additional income-based LLC fee on top of the $800.

For contractors working across city or county lines, sales tax obligations can also multiply. Each jurisdiction where you install materials may require a separate registration and filing. See our guides on handling sales tax in multiple cities or counties and sales tax exemption on job supplies for the rules that trip up multi-location contractors.

What records should a multi-member LLC keep to protect both partners?

The records that protect you in a partnership are the same ones that protect you in an audit. I tell every client to maintain four documents from day one:

• A written operating agreement that spells out each member's role, capital contribution, profit-split ratio, and what happens if a member leaves or dies.
• Minutes or notes from member meetings that document major decisions — taking on debt, buying equipment, changing the profit split.
• Time records or job logs showing which member worked on which jobs, especially if you use a special allocation that gives more profit to the working member.
• Separate bank accounts for the business. Never commingle personal and business funds in a multi-member LLC — it's the fastest way to pierce the liability shield and create a bookkeeping nightmare at tax time.

Those records are what carried the day for the Johnson brothers. They could show what each owner did and that the business still prospered. Without that paper trail, the IRS has nothing to measure against, and they'll substitute their own judgment for yours.

For a broader view of how entity choice affects your tax picture across the contractor lifecycle, visit our contractor tax planning hub for the full library of guides.

If you've recently brought on a partner and want a second set of eyes on how your multi-member LLC taxes should be structured, book a call with our office. We work with trade contractors every day and can walk through your specific numbers. Book a meeting here.