The Choice of Organizational Form: Why Some Entities Should Consider Becoming Limited Liability Companies

By Cecil, H. Wayne; Ciccotello, Conrad S. et al. | Journal of Accountancy, December 1995 | Go to article overview

The Choice of Organizational Form: Why Some Entities Should Consider Becoming Limited Liability Companies


Cecil, H. Wayne, Ciccotello, Conrad S., Grant, C. Terry, Journal of Accountancy


Organizational forms such as limited liability companies (LLCs) and limited liability partnerships (LLPs) are emerging as desirable alternatives for many businesses. While LLPs are a popular choice for CPA firms, LLCs appeal to a wide range of entities. Which clients should CPAs advise to become LLCs? Based on tax and operating considerations, LLCs are not the best fit for all businesses. This article discusses the federal income tax rules for LLCs and compares them to the tax treatment of C corporations, S corporations and limited partnerships.

Tax considerations and reduced operating and ownership restrictions favor selecting LLCs--which, like partnerships, generally are not taxable entities. State laws also permit LLC owners (properly known as "members") to limit their liability to the amounts they invested, plus any capital commitments, making LLCs more attractive than partnerships. The reduced operating and ownership restrictions also will make them more attractive to some S corporations.

THE LEGAL DEVELOPMENT OF LLCs

Exhibit 1, page 46, shows that as of November 1985, 47 states and the District of Columbia permitted the formation of LLCs. Legislation is under consideration in all three remaining states. The pace of adoption has been rapid. Thirty-two states have adopted LLC statutes since 1992. (For a discussion of the general business and tax implications of LLCs, see "Tax Aspects of Limited Liability Companies," JofA, Sep.92, page 48.)

The key tax issue for LLCs is achieving partnership status for federal income tax purposes. Before 1993, revenue ruling 88-76, which addressed Wyoming's LLC statute, was the primary authority. In 1993, the Internal Revenue Service issued 12 revenue rulings that expanded the authority for recognizing LLCs as partnerships on the federal level. Since 1993, five additional rulings have been issued, each covering a different state. All conclude that LLCs can achieve partnership status for federal income tax purposes. (Information on the rulings can be found in exhibit 1.)

TREATMENT AS PARTNERSHIPS

Compliance with a state's LLC statute (Delaware is a notable exception) generally ensures an entity will be classified as a partnership. For LLC members to be taxed like partners, LLCs must avoid two of the four corporate characteristics in Treasury regulations section 301.7701-2:

1. Limited liability.

2. Centralized management.

3. Continuity of life.

4. Free transferability of interests.

Each of these characteristics is assigned equal weight in determining how a business is classified.

By design, LLCs have limited liability and, for practical business purposes, management generally is centralized. Accordingly, LLCs must avoid continuity of life and free transferability of interests to achieve partnership status. For example, revenue ruling 88-76 says that if an LLC organizes so that the assignee of a member's interest may become a member without the remaining members' consent (free transferability of interests) or if the LLC continues to operate after an event that terminates a member's interest (continuity of life), the entity will be taxed as a C corporation.

To obtain favorable federal tax status, LLCs also must avoid classification as publicly traded partnerships. This means that partnership interests cannot be traded or be readily tradable on established securities markets, in secondary markets or their equivalents--IRS notice 88-75 is the primary authority on determination of trading of partnership interests.

CHOOSING AN LLC--A HYPOTHETICAL EXAMPLE

Exhibit 2, page 48, illustrates the tax treatment under two scenarios--all net income is distributed to owners or is reinvested in the business--when the owners do not participate in management. Exhibit 3, page 50, shows the tax treatment when the owners participate in management and all net income is distributed to them as wages. …

The rest of this article is only available to active members of Questia

Sign up now for a free, 1-day trial and receive full access to:

  • Questia's entire collection
  • Automatic bibliography creation
  • More helpful research tools like notes, citations, and highlights
  • Ad-free environment

Already a member? Log in now.

Notes for this article

Add a new note
If you are trying to select text to create highlights or citations, remember that you must now click or tap on the first word, and then click or tap on the last word.
One moment ...
Default project is now your active project.
Project items

Items saved from this article

This article has been saved
Highlights (0)
Some of your highlights are legacy items.

Highlights saved before July 30, 2012 will not be displayed on their respective source pages.

You can easily re-create the highlights by opening the book page or article, selecting the text, and clicking “Highlight.”

Citations (0)
Some of your citations are legacy items.

Any citation created before July 30, 2012 will labeled as a “Cited page.” New citations will be saved as cited passages, pages or articles.

We also added the ability to view new citations from your projects or the book or article where you created them.

Notes (0)
Bookmarks (0)

You have no saved items from this article

Project items include:
  • Saved book/article
  • Highlights
  • Quotes/citations
  • Notes
  • Bookmarks
Notes
Cite this article

Cited article

Style
Citations are available only to our active members.
Sign up now to cite pages or passages in MLA, APA and Chicago citation styles.

(Einhorn, 1992, p. 25)

(Einhorn 25)

1

1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

Cited article

The Choice of Organizational Form: Why Some Entities Should Consider Becoming Limited Liability Companies
Settings

Settings

Typeface
Text size Smaller Larger Reset View mode
Search within

Search within this article

Look up

Look up a word

  • Dictionary
  • Thesaurus
Please submit a word or phrase above.
Print this page

Print this page

Why can't I print more than one page at a time?

Full screen

matching results for page

Cited passage

Style
Citations are available only to our active members.
Sign up now to cite pages or passages in MLA, APA and Chicago citation styles.

"Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn, 1992, p. 25).

"Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn 25)

"Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences."1

1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

Cited passage

Thanks for trying Questia!

Please continue trying out our research tools, but please note, full functionality is available only to our active members.

Your work will be lost once you leave this Web page.

For full access in an ad-free environment, sign up now for a FREE, 1-day trial.

Already a member? Log in now.