For years, entrepreneurs, partnerships of professionals or others, and investors have sought a business form that offers the beneficial tax status and flexibility of a partnership along with the limited liability of owners afforded by a corporate structure. The vehicles generally available have been limited partnerships with corporate general partners and S corporations. Professionals in some states have been able to achieve some degree of limited liability by practicing in professional corporations or partnerships with one or more professional corporations as partners. While each vehicle offers some benefits, each has certain drawbacks. A new entity, the limited liability company (or LLC), has emerged as an alternative business form. A properly structured LLC eliminates certain drawbacks of the limited partnership, the S corporation, and the professional corporation and combines the partnership's beneficial Federal tax status and flexibility with the corporation's limited liability of owners.
As set forth on the accompanying map, there are now 18 states that permit the formation of LLCs and two states that recognize LLCs formed in other states. LLC Statutes are pending or are being considered in approximately 28 other states, and the National Conference of Commissioners on Uniform State Laws is drafting a uniform LLC statute. In New York, LLC bills were introduced in both houses of the New York State Legislature this past spring (such legislation is referred to in this article as the "New York Legislation"). Because of certain revenue concerns, the New York Legislature recessed for the summer without taking any action on these bills, thereby deferring consideration until the 1993 legislative session.
BULLETPROOF OR FLEXIBLE: WHICH IS BEST?
LLC statutes typically are either "bulletproof" or "flexible."
BULLETPROOF STATUTES. The LLC statutes in Colorado, Virginia, and Wyoming are examples of bulletproof statutes. They contain mandatory provisions concerning limited liability, transferability of interests, centralized management, and continuity of life, which provisions, as discussed later, are designed to ensure that an LLC organized under them will be classified as a partnership for Federal tax purposes.
FLEXIBLE STATUTES. The New York Legislation and the Delaware, Illinois, Maryland, and Texas statutes are examples of flexible statutes. They allow an LLC's organizers broad flexibility in structuring the LLC, and allow the provisions concerning transferability of interests, centralized management, and continuity of life to be varied by the agreement of the owners of the LLC, with "default" provisions that otherwise govern. It should be emphasized that by not following the default provisions in the flexible statutes there is the risk that the LLC will not he structured properly from a Federal tax standpoint. The costs of such a mistake could be enormous. Accordingly, before a decision is made to depart from the default rules, careful attention should be given to the question of whether the resulting structure will continue to receive Federal partnership characterization.
The first LLC statute was adopted in Wyoming in 1977. In 1982, Florida adopted a similar statute. In 1988, the IRS published Rev. Rul. 88-76 classifying a Wyoming LLC as a partnership for Federal income tax purposes. Subsequently, the IRS has issued a number of private letter rulings treating limited liability companies as partnerships. Classification as a partnership or corporation for Federal income tax purposes is made by reference to Sec. 7701 of the Internal Revenue Code of 1986, as amended (the "IRC"), and the regulations promulgated thereunder. The so-called Kintner regulations (Treas. Reg. Sec. 301.7701-2) identify six characteristics indicative of corporate status: 1) the presence of associates, 2) an objective to carry on business and divide the gains, 3) continuity of life, 4) free transferability of interests, 5) centralization of management, and 6) limited liability. …