Limited liability company: A new entity for the United States, The

limited liability company: A new entity for the United States, The

Bagley, William D

By the end of 1993 thirty-six states had enacted acts providing for formation of a new business entity, the Limited Liability Company (the “LLC”).(1) Within a year all states will have enacted Limited Liability Company Acts.

The LLC is a statutory business entity that fits between the corporation and the partnership. It fills the business need recognized, but not satisfied, by the S corporation and the limited partnership. The advantages of (1) flow-through tax treatment, (2) flexibility, and (3) limited liability are causing the LLC to replace the general partnership, the limited partnership, the S corporation, and the closely held corporation as the better alternative. It is also the vehicle of choice for joint ventures, especially corporate joint ventures.

A new entity for the United States. The limited liability company is not the offspring of the corporation or of the partnership. It has its own deep and very adequate roots. Limited liability companies are neither new nor strange to businessmen in the civil law countries of Europe and Latin America. LLCs have their origin in the 1892 German company known as Gesellschaft mit beschrankter Haftung.(2)

Wyoming in 1977 became the first American state to enact a true limited liability company statute. This Act was a result of the direct effort of Hamilton Brothers Oil Company, a company involved in international oil and gas exploration using Panamanian limited liability companies. Hamilton was about to embark in a joint venture for oil and gas exploration in the United Kingdom sector of the North Sea, and preferred to operate through a United States entity. With the assistance of Peat, Marwick, Mitchell and Co. in Dallas Texas, Hamilton Brothers Oil Company drafted legislation which was presented to Wyoming Legislature, and adopted without amendment.(3) On September 2, 1988, eleven years later, the Internal Revenue Service finally issued its revenue ruling on a Wyoming LLC, holding it to be classified as a partnership for federal tax purposes.(4) Prior to the IRS 1988 Wyoming Revenue Ruling, the Florida Limited Liability Company Act was adopted to facilitate its business with Central and South America.(5)

In its Wyoming Ruling the IRS applied a four factor “resemblance test” under the Kintner Regulations to determine whether the entity was to be classified as a partnership or a corporation for tax purposes.(6) The Service determined if the entity avoids two of the four critical “corporate characteristics” it will be recognized as a partnership for federal tax treatment. The same standard has been used in the 14 subsequent LLC Revenue Rulings.(7)

State LLC Acts-The great experiment. The sequence of state adoption is: In 1977 Wyoming; 1982 Florida; 1990 Colorado and Kansas; 1991 Nevada, Texas, Utah, and Virginia; 1992 Arizona, Delaware, Illinois, Iowa, Oklahoma, Maryland, Minnesota, Louisiana, Rhode Island, and West Virginia; and in 1993 Alabama, Arkansas, Connecticut, Georgia, Idaho, Indiana, Michigan, Missouri, Montana, Nebraska, New Hampshire, New Jersey, New Mexico, North Carolina, North Dakota, Oregon, South Dakota and Wisconsin.

Though the Internal Revenue Service has not changed its 1988 Revenue Ruling on classification for federal tax purposes, each state has a different statutory approach to the formation and operation of LLCs. Along with the thirty-six different state acts, on November 19, 1992, a subcommittee of the ABA Business Law Section issued its Prototype Limited Liability Company Act. The ABA prototype and its earlier drafts generated provisions now found in many state acts. Its text and annotations are useful legislative history.(8) A “Model Act” is expected to be “promulgated” in August of 1994 by the National Conference of Commissioners on Uniform State Laws. Under all acts, uniform or not, the practitioner must fit the window afforded by the Internal Revenue Service while following the state act. In many cases, compliance with the state act does not insure favorable tax treatment.

State LLC Acts have evolved into two types, (1) the bullet-proof act, where compliance with the state act retains the corporate characteristic of limited liability and avoids continuity of life and free transferability of interest. This assures favorable tax treatment, whether or not the company opts for centralized management.(9) And (2) the flexible act, where the organizers can elect the corporate characteristics they wish to keep. For example, the LLC can have the corporate characteristic of limited liability and continuity of life or free transferability of interest if the company is managed by members.(10)

After the requirements of the state act are met, if the company passes the IRS four factor classification test, it is recognized as a partnership for federal tax purposes. The result is a company with the advantages of (1) flexibility and (2) corporate-like limited liability for its owners and managers, while enjoying (3) partnership tax treatment.

For maximum contractual flexibility, most states do not impose unnecessary restrictions or mandate cumbersome and ill-fitting corporate or partnership concepts in their statutes. The Prototype ABA Act is a good example. There is no need for state LLC Acts to include pages of statutory boilerplate from their corporate and partnership acts, though the temptation is often impossible to overcome.

IRS revenue rulings–The common denominator. The goal of the LLC is to retain limited liability for all of its members and managers and still be classified by the IRS for partnership tax treatment. As set out in the fifteen IRS LLC Revenue Rulings identified in footnote 7, for federal tax purposes the company needs to be classified (or identified) before its treatment under the Internal Revenue Code can be determined. For a limited liability company to receive the advantage of partnership tax treatment it must avoid at least two of the four critical corporate characteristics to be recognized as a partnership, rather than a corporation. Because limited liability is a recognized corporate characteristic, three other critical corporate characteristics must be identified and at least two avoided.

A “partnership,” for Federal tax purposes, is broadly defined as any business or venture that is not a corporation or a trust. A partnership is an association of two or more persons as co-owners to carry on business for profit. The standards which are to be applied in determining whether the organization is classified as a partnership are found in the Procedure and Administration Regulations 26 CFR 301.7701. If the entity qualifies for partnership tax treatment, the partnership provisions in Subchapter K of the Internal Revenue Code apply. (I.R.C. secs701-709.)

In 1935, five corporate characteristics were identified by the U.S. Supreme Court in Morrissey v. Comm’r in holding that the business trust would be recognized and taxable as a corporation.(11) Since the 1988 Revenue Ruling on classification of an LLC, four corporate characteristics are reviewed to make the distinction and determine the classification. They are (1) continuity of life, (2) centralization of management, (3) limited liability, and (4) free transferability of interest. A business organization (syndicate, group, pool, joint venture, or other unincorporated association) will be taxed as a partnership it lacks two of these four corporate characteristics. The IRS gives these four characteristics equal weight and applies state law to determine whether these characteristics exist.(12) The presence or absence of these characteristics depends on the facts of each individual case. Other factors may be found in particular cases which may be significant in classifying the organization.(13)

After the 1988 Revenue Ruling on a Wyoming LLC almost five years passed before the next Ruling. This caused concern about the IRS commitment. The desired reaffirmation came in the form of 1993-1994 Revenue Rulings on LLCs formed in Germany, Virginia, Colorado, Nevada, Delaware, Illinois, West Virginia, Florida, Rhode Island, Utah, Oklahoma, Arizona, Louisiana and Alabama.(14) The IRS stands firm in its approval, and in the standard applied. It is settled that passing the four factor “resemblance test” for entity classification means an organization will be taxed as a partnership.

The fact that the entity was properly formed pursuant to a state limited liability company statute does not assure IRS partnership tax treatment. The draftsmen must exercise care to avoid unnecessary corporate characteristics (or resemblances). For example, LLCs with a “Business Succession Agreement” will probably not be able to establish that they lack continuity of life. Also, free transferability of interest may result from any prior agreement concerning admission of transferee as members, even one “to not unreasonably withhold consent” to the admission to membership of a future transferee. In addition, use of the word “manager” may result in centralization of management even if all members participate in management.(15) Lenders concerns about continuity are usually resolved by the personal guarantee of the members. Any agreement designed to compel continuance made prior to the event of withdrawal will jeopardize partnership tax treatment, if avoidance of the corporate characteristic of continuity of interest is necessary to pass the IRS four factor classification test.(16)

The new Utah Revenue Ruling (93-91) is a major “clarification” of the requirements necessary to avoid the corporate characteristic of free transferability of interest. It is now settled that, allowed by statute and the operating agreement, a majority in interest of the remaining members (not owners) may agree to admit a transferee as a new member.(17) Prior revenue rulings, finding free transferability of interest was avoided, were based on fact situations that required the consent of all remaining members.

Outstanding classification questions yet to be resolved by the IRS. The Service has yet to clarify the following questions. (1) With respect to the ability and procedure to continue after withdrawal of a member, the new Utah Revenue Ruling (93-91) finds and determines that, if allowed by the state act and the operating agreement, a majority in interest of the remaining members may agree to continue the company. This standard to avoid the corporate characteristic of continuity of life is clearly safe if all owners are members. However, if ownership is shared with transferees, would the necessary vote be a vote of a “majority in interest of the remaining owners?”(18) (2) How much can the “events of dissolution” be limited by the state act and still serve to avoid the corporate characteristic of continuity of life? (3) How will the Service treat the one member LLC now authorized by several state statutes? (4) Does the right to continue need to be provided in the statute? And reserved in the Articles? These are areas where private letter rulings and public statements by IRS insiders have sent mixed signals.

Limited liability company features. Under state acts, the LLC owners are either “members” or “transferees” rather than “partners,” “limited partners” or “shareholders.” An owner can be any individual or entity. The company is a statutory entity that may carry on any lawful business. An owner’s interest in a LLC can be evidenced by a certificate of ownership, and it is usually set out in the Operating Agreement (Regulations) or other ownership record as a percentage or units of ownership. Unless otherwise provided, participation and distributions are based on the agreed value of the capital contribution of each member. The Operating Agreement is a combination of a Partnership Agreement and Corporate By-Laws. Concerning the capital commitment, allocations, governance and operation of the company it is a contract which should be in writing, negotiated, and signed by all members.

The most important difference between LLCs and partnerships is that LLC members are not personally liable for the debts of the company. The exposure of members of an LLC for the debts or obligations of the company is limited to their capital commitment, absent extraordinary circumstances. Like corporate shareholders, LLC owners enjoy the statutory grant of limited liability.

The most important differences between LLCs and an S corporations are (1) the flexibility of the LLC, and (2) avoidance of corporate “tax events” upon winding-up. The LLC is not subject to the same “traps for the unwary” found in the S corporation. Subject only to practical limitations, an LLC may have an unlimited number of members. Unless limited by the state act, members may include corporations, nonresident aliens, partnerships, trusts, pension plans, and charitable organizations. Most state acts allow any individual or entity to be a member. Also, unlike an S corporation, an LLC may be part of an affiliated group. The one-class-of-stock limitations applicable to S corporations do not apply to LLCs. Therefore the members of an LLC have the flexibility of a partnership in structuring the allocation of profits, losses, and distributions in differing ratios.

To achieve IRS classification for partnership tax treatment the company usually avoids the corporate characteristic of free transferability of interest, though free transferability may be adopted (with great care) under the “flexible” statutes.(19) Unless otherwise provided, “economic interest” is freely transferable, but “membership interest” (the right to participate in management) may be obtained only with consent of the other members given after the transfer. The assignee or transferee of an ownership interest is entitled to receive only the “economic interest,” the share of the distributions due the transferor, and may not participate in the management of the company. The transferee is similar to a limited partner.

LLC members are encouraged by the IRS classification criteria to manage the business themselves and avoid the corporate characteristic of centralization of management. When necessary, this can be made clear by declaring in the Articles that “management is by the members.” In this capacity the members may direct (manage) the operation of the LLC and employ others as needed to conduct its business. Yet, if desired, members may adopt this corporate characteristic by designating one or more “managers’ to direct and conduct the business of the LLC. Managers need not be members. Unless otherwise restricted in the Articles, any manager (member or not) may bind the company.

To avoid the corporate characteristic of continuity of life the LLC Acts provide a list of events that will trigger the dissolution of an LLC. The events of dissolution occur upon the withdrawal of a member. They include the death, retirement, resignation, bankruptcy, dissolution, or incompetence of a member. Unless otherwise restricted by the state statute, after the event of dissolution, a majority in interest of the remaining owners may agree to continue the business.(20) Otherwise, the process is to wind-up the business. Upon winding up, as required by statute, the assets of an LLC are distributed to satisfy claims of company creditors and then to its members. As a part of winding up an LLC is to file Articles of Dissolution with the Secretary of State. Upon continuing, an amendment of the Articles may be required to reflect the changes.

Formation of an LLC. The LLC formation process is similar to that of a corporation. The pattern is that Articles of Organization will be filed by members or by their representative (the “organizer”). The Articles contain (1) the name of the company, with the limited liability company designation as part of the name, (2) provision for a registered office and agent, (3) a period of company duration, and (4) “other provisions” not inconsistent with law. However, in Wisconsin the Articles do not contain a period of “duration” and “other provisions” are not allowed. In addition, many statutes require (5) a statement of purpose, (6) a statement reserving the right to add new members, (7) reservation of the right to continue after an event of dissolution, (8) a statement on capitalization, and (9) the name and address of each member of management. When allowed, the Articles are the first and best place to give notice of any limits on powers or purpose.

For “partnership” tax treatment the IRS requires that the entity have two or more members.(21) An IRS study group is now reviewing potential pass-through tax treatment for the one-person LLC now allowed in several states, including Texas, Georgia, Idaho, New Jersey and Montana. In most other states the ability to continue is lost if membership drops below two, though some states, including Minnesota, Nebraska and North Dakota, allow the survivor a reasonable period to find a second member.

The Operating Agreement is the key document in the LLC. It takes the place of the Partnership Agreement and the Corporate By-Laws. Among other things, it should address all matters covered by the LLC Act and IRS “default provisions.” It is the opportunity to “otherwise provide.” Considerations upon formation include (1) entity selection, (2) negotiating an operating agreement among the participants, (3) selection of a business name, (4) identification of the business purpose, (5) agreements on capitalization, voting, management, distributions, and allocations, (6) a policy that conforms with the state statute dealing with return of capital upon withdrawal of a member or assignee, and (7) a policy on the addition of new members. Allocation and capital account provisions need to be reviewed by tax advisors.

Finances of the LLC. LLC statutes allow flexibility in the capital structure of the company. The capital commitment of a member is determined upon admission, and under most acts members may contribute cash, property, services rendered, or a promissory note for their membership interest. Members of an LLC may agree to the voting, allocation, distribution variations permitted in partnerships by provision in the Operating Agreement. Absent other agreement, most statutes provide that voting, profit or loss allocation, and distributions are based on the percentage of the members’ ownership interests.

Practitioners need to provide (or obtain) competent advice on matters dealing with partnership taxation. Allocation agreements, active/passive considerations, and the “at risk” concept all affect individual tax treatment. Individual capital account variations need to be anticipated.

Attention needs to be given to statutory provisions that “unless otherwise provided” require an untimely return of capital contribution upon withdrawal of a member. To not “otherwise provide” may result in a disaster. Most Acts prohibit any distribution or return of capital contributions that would cause the LLC to become insolvent. Members who vote for, or assent to, such a prohibited distribution may be jointly and severally liable to the LLC to return or replace the distribution. Under some acts a creditor of the company can enforce that obligation as well as the unmet capital commitment of a member. Some acts define the rights of a creditor of a member to “charge” the owner’s economic interest for payment of a debt of an owner.

The limits of limited liability. In a limited liability company neither the members of a limited liability company nor the managers of a limited liability company managed by a manager or managers are liable in any manner for a debt obligation or liability of the limited liability company. The legislative intent is to provide corporate-like limited liability for owners and agents. Yet, there is cause to believe that the common law doctrine of piercing-the-veil or the alter ego doctrine do apply when the relevant considerations are present. The new issue being addressed by state legislators is of the imposition of personal liability upon members of management for the payment of taxes, tax withholdings, remittance of sales tax, and premiums for unemployment compensation and workers compensation.

Actionable negligence of an employee, owner or manager, render that person answerable. Also, CIRCLA and securities concerns are not avoided by the mere fact that a new business entity is used. With respect to the debts of an owner, some statutes provide for a charging order, and this has been argued to be an exclusive remedy and bar foreclosure.

Most LLC statutes provide increased protection, by following the provision in the 1977 Wyoming Act that a member of a limited liability company is not a proper party to proceedings by or against a limited liability company, except where the object is to enforce a member’s right against or liability to the limited liability company.(22) This is appreciated by an owner who has been added as a party to a suit against the company, and had to reflect the contingent liability on his financial statement until the company dispute was resolved.

Recognition: The foreign LLC. A “foreign limited liability company” is defined in most state acts as an unincorporated entity formed in another jurisdiction having characteristics substantially similar to those of a domestic LLC. If a foreign LLC transacts business in a state in violation of its registration requirements, sanctions apply. Such failure will not, however, impair the validity of any contract or prevent the foreign LLC from being a defendant in civil suits.

LLC states intend that the legal existence of their LLCs be recognized in other jurisdictions, and be granted the protection of the full faith and credit and commerce clauses of the United States Constitution. Also, most registration acts provide that the laws of the jurisdiction under which a foreign LLC is organized will be recognized to govern its internal affairs and the liability of its members.

Absent state LLC statutory registration requirements, there may be some uncertainty as to whether the entity should attempt to register. Will it be treated fairly by the tax authorities or the courts of the new jurisdiction? States that have addressed this consideration in state revenue regulations identify themselves to be “conformity states,” which means that they will recognize the LLC according to the same classification criteria imposed by the Internal Revenue Service. If an LLC qualifies for federal partnership tax treatment it will qualify for state partnership tax treatment. See, e.g., California Franchise Tax Board Notice 92-5. If a procedure for LLC registration is not enacted, the best practice is to comply with that required of partnerships.

Uses–The better alternative. The LLC is useful for any business or estate plan where the owners desire limited liability, pass-through tax treatment, and the ability to control. An LLC is preferred to a general or limited partnership because no person or entity needs to assume the liability exposure of a general partner. All members can participate in the management of the business without personal liability for the debts of the company. Since owners can be either individuals or entities, the LLCs are well-suited for joint ventures including real estate, oil and gas, plant construction and research and development. LLCs are also well-suited for small businesses, professional service firms, closely held businesses, and as an operational estate planning tool.

Because the LLC does not have restrictions regarding who can be owners or what can be owned, it is useful for venture capital transactions where member investors, corporate and otherwise, want both pass-through tax treatment and the ability to directly control business operations. Similarly, an LLC can be a useful entity for acquisitions, because it is permitted to differentiate among the members with respect to distribution, management, and voting rights. As practitioners become more familiar with LLCs, their expanded uses are reported. Examples include:

1. Real Estate. The features of liability protection and partnership tax treatment coupled with the ability for all partners to be involved in management are sufficient to cause LLCs to replace joint venture and partnerships in real estate ventures. The ability of the company to hold and pass title after the death or incompetency of a owner, tends to simplify estate and multi-state problems, whether the remaining members elect to wind-up or to continue the company.

2. General and Family Business. Liability protection, federal tax pass through features, and absence of the “S” corporation requirements and restrictions make the LLC the preferred entity for most business undertakings. Management and ownership flexibility in the LLC make this entity even more attractive. In LLC formation the advisor has substantial freedom to create a management and ownership structure tailored to meet the particular needs of the individuals in the business venture. It is an opportunity to involve others and still retain control.

3. Professional. In an era when professionals are being made to pay for the independent acts of partners, and liability to third parties is on the rise, the LLC is increasingly attractive. While the professional may not save himself from his own malpractice, he may save his home when a partner or employee is in error. In addition to limited liability, the LLC flow-through tax treatment makes it a better alternative.(23) Many states make special provisions for the professional LLC (the “P.L.L.C.”), while others accept this activity as a “lawful business” allowed in the general purpose provision of their LLC Acts. Only Rhode Island prohibits LLC use by professionals, and that restriction is expected to be removed in the next legislative session.

4. Venture Capital. With the total contractual flexibility of the LLC, a venture capitalist can exercise the control he desires, define those situations triggering sale rights, have pass-through tax benefits, and still possess the desired limited liability protection. Easy conversion to a C corporation is possible when the venture proves successful and goes public. There are no membership share restrictions, citizenship requirements, or ownership criteria in the LLC. No other entity can compete with the LLC for venture capitalization.(24)

5. Corporate Joint Ventures. The filing of consolidated tax returns allows full deductibility of employee benefit plans in corporate joint ventures using an LLC as the operating entity. Flexibility, control and limited liability are important considerations. The larger LLCs to date have been corporate joint ventures.

6. A Mortgage Substitute. As a result of the total contractual flexibility, in the Operating Agreement a lender (member with preference rights) can provide itself a fixed percentage of return on its investment (interest), a priority capital return (amortized payout), and the right to own in the event of failure of the company to pay as agreed (foreclosure). This avoids problems and delays that are associated with bankruptcy and redemption periods.

7. Estate Planning. The LLC is replacing family corporations and partnerships as the vehicle of choice in estate planning. A family business can operate in the LLC, providing a level of protection to other family assets. Discounted valuations upon the gifting or nonvoting minority interests are often easier to establish and justify than in other traditional estate planning entities. An assigned or transferred “economic” interest, as opposed to a membership interest, will also afford opportunities for discount calculations.(25)

8. Non-American Business in the U.S. The LLC is a commercial entity with which most non-American businessmen and their advisors are familiar. It is possible to provide substantial estate protection for the foreign businessman. Writers suggest that use of on shore tax, however, can result in tax free activities of American LLCs owned by non-American citizens or permanent residents.(26)

9. Immigration. The LLC provides interesting alternatives for non-U.S. based private and corporate investors wanting to do business in the United States. The LLC allows aliens to obtain their U.S. immigration goals while having the protection of limited liability. Proper structuring of the LLC with decentralized management may allow the alien investor to win a greater percentage of the employer company without jeopardizing his immigration status.(27)

10. Minority Business Entity. The ability to make flexible provisions for management as well as for allocations and distributions make the LLC a fair and functional entity to promote minority business enterprises. The Operating Agreement can provide for the return of unequal contributions to capital before distribution of profits and surplus according to the agreed percentage of ownership.

11. Asset Protection. The LLC is an appropriate entity to hold assets and protect them from related or unrelated risk. For example, see PLR 93-300009 dealing with an asset holding LLC with its companion identical ownership S Corporation construction company. The LLC is an entity where risks can be compartmentalized.

The list of LLC uses continues to expand.

Conclusion. The joy of the LLC is total contractual flexibility to tailor an entity to meet the special needs of each client. Situations not specifically addressed by the state statute may result in some uncertainty because LLCs are new, yet this is an advantage in cases where flexibility is important. Relevant concepts from partnership and corporate law provide direction that can be drafted into the Articles of Organization or the Operating Agreement. As a result of its flexibility, limited liability, and partnership tax treatment, the LLC is the better alternative!

FOOTNOTES

1. Limited Liability Company Acts have been enacted in Alabama, Arizona, Arkansas, Colorado, Connecticut, Delaware, Florida, Georgia, Idaho, Illinois, Indiana, Iowa, Kansas, Louisiana, Maryland, Michigan, Minnesota, Missouri, Montana, Nebraska, Nevada, North Carolina, North Dakota, New Hampshire, New Jersey, New Mexico, Oklahoma, Oregon, Rhode Island, South Dakota, Texas, Utah, Virginia, West Virginia, Wisconsin and Wyoming. Mississippi has enacted statutes to deal with out of state LLCs, though it has not yet enacted its own LLC Act. This is the course taken in 1992 by Indiana and Georgia, both of which enacted their own LLC Acts in 1993.

2. Molitor, Die Auslandische Regelung der G.m.b.H. und die deutsch Reform (1927) and Hallstein, “Die Gessellschaft mit berschranketer Haftung in den Auslandsrechten,” 12 Aitscrift fur auslandisches und internationales Privatrecht 341 (1938). For additional information on foreign limited liability companies see: DeVries & Junger,” Limited Liability Contract: The GmbH, COLUMBIA L. REV. 866 (1964) Eder, Limited Liability Firms Abroad, 13 U. PITT L. R. 193 (1952); and Vasts, Reforming the “Modern” Corporation: Perspectives from the German, 80 HARV. L. REV. 23 (1980).

3. Letter dated June 5, 1992 from A.J. Miller, Executive Vice President and Chief Financial Officer, Hamilton Brothers Oil Company, to Wyoming Supreme Court Chief Justice, Walter Urbigkit. This letter is quoted in its entirety in Bagley and Whynott, The Limited Liability Company: The Better Alternative, Fourth Edition, James Publishing Company, p. 1.451. Adoption was in Chapter 158, Session Laws of Wyoming, 1977.

4. Rev. Rul. 88-76.

5. Johnson, The Limited Liability Company Act, 11 FLA. S.L. REV. 387(1983-1984).

6. Rev. Rul. 88-76; 26 CFR 301.7701-2(a)(2) and (3); United States v. Kintner, 216 F.2d 418(9 Cir. 1954).

7. Wyoming (Rev. Rul 88-76), Germany (Rev. Rul 93-4, a modification of Rev. Rul. 77-214), Virginia (Rev. Rul. 93-5), Colorado (Rev. Rul. 93-6), Nevada (Rev. Rul. 93-30), Delaware (Rev. Rul. 93-38), Illinois (Rev. Rul. 93-49), West Virginia (Rev. Rul. 93-50), Florida (Rev. Rul. 93-53), and Rhode Island, (Rev. Rul. 93-81), Utah (Rev. Rul. 93-91), Oklahoma (Rev. Rul. 93-92), Arizona (Rev. Rul. 93-93), Louisiana (Rev. Rul. 94-5) and Alabama (Rev. Rul. 94-6).

8. Prototype Limited Liability Company Act of the American Bar Association Business Law Section Subcommittee on LLCs. This “Prototype Act” and its annotations are reproduced in their entirety as part of the manual The Limited Liability Company, Second Edition, James Publishing Company, 1994.

9. Eg., Wyoming, Nevada, Virginia and South Dakota.

10. Eg., Arizona, Illinois, Delaware, Maryland, New Jersey and Texas. Under a flexible Act partnership tax treatment can be lost if appropriate provisions are not adopted in the LLCs Articles of Organization or Operating Agreement. See, e.g., Rev. Rul. 93-38, 1993-21 I.R.B. 4 (concerning Delaware LLCs).

11. 296 U.S. 344 (1935).

12. Larson v. Commissioner; 66 T.C. 159, 172 (1976). See also the Revenue Rulings cited in footnote 7.

13. 26 CFR 301.7701-2(a)(1) and see Rev. Rul. 79-106 for a listing of “significant other factors.” This additional “other factor” criteria has not been advanced in the later LLC Revenue Rulings.

14. See footnote 7.

15. Letter dated July 24, 1993, from the Office of Chief Counsel, Internal Revenue Service, to the National Conference of Commissioners on Uniform State Laws. See also the Colorado Revenue Ruling (Rev. Rul. 93-6) on centralization of management.

16. An alternative is an option agreement that provides that should the vote to continue fail, those who desire to continue have the option to purchase the assets of the company. Some have sought to avoid this problem by an agreement between the lender and the members that mandates continuance for the duration of the loan. These shades of grey promise fertile fields of future litigation. Care must be taken to avoid at least two of these four critical corporate characteristics.

17. Section 301.7701-2(e)(1) of the Procedure and Administrative Regulations. See Rev. Rul. 93-91.

18. Section 301.7701-2(b)(1) of the Procedure and Administrative Regulations, addressing general and limited partnerships applies also in classifying LLCs, yet it makes a distinction between general partners (members) and limited partners (transferees). See Rev. Rul. 93-91.

19. Slater. “Free Transferability: A One Factor Test?” 1 LLC Rep. 93-306 (1993); Rev. Rul. 93-91.

20. 26 CFR 301.7701-2(b)(1) as “clarified” June 14, 1993; 1 LLC Rep. 93-101 and 93-403 (1993); Rev. Rul. 93-91.

21. Uniform Partnership Act sec6(1).

22. Session Laws of Wyoming, 1977, sec17-323 on Parties to Actions, provides: “a member of a limited liability company is not a proper party to proceeding by or against the limited liability company, except where the object is to enforce a member’s right against or liability to the limited liability company.”

23. Bagley, “The Professional Limited Liability Company,” 1 LLC Rep. 93-401 (1993).

24. Ellis, “LLCs and Theatrical Financing,” 1 LLC Rep. 93-301 (1993).

25. Pluth, “Use of LLCs in Estate and Family Wealth Planning,” 1 LLC Rep. 93-401 (1993).

26. Neufield, “U.S. Tax Treatment of Foreign Investors and Capital in LLCs,” 1 LLC Rep. 93-104 (1993).

27. Schrader, “Benefits of Limited Liability Companies For Immigration Purpose,” 1 LLC Rep. 93-201 (1993).

William D. Bagley is a Cheyenne, Wyoming attorney. He is co-author of Wyoming Corporate Law and Practice (Pioneer Printing, 1990, Supp. 1991); co-author of The Limited Liability Company: The Better Alternative (Pioneer Printing, 1991, Second Edition, James Publishing 1994) and co-editor of The Limited Liability Company Reporter (1993-94). He is a frequent speaker at Advanced Limited Liability Company Seminars. In 1990-91 he served as chairman of the Wyoming Bar Business Law Section.

Copyright Commercial Law League of America Mar/Apr 1994

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