@222 CHAP 2 旼컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴커 쿗imited Liability Companies--A New Fourth Choice� 읕컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴켸 The age-old choice of entity in starting a business has al- ways been a threefold one (except for such oddities as the "Massachusetts business trust"): sole proprietorship, part- nership, or corporation. But now there is a new kind of business entity, which has recently arrived on the scene: the "limited liability company." A growing number of state legislatures around the U.S. have enacted laws in recent years that permit the formation of these new legal entities. @CODE: AL AZ AR CO DE FL GA ID IL IN IA KS LA MD MI MN MT NB NV ND OK RI SD TX UT VA WV WY @STATE is one of the states that has enacted an "LLC" law. @CODE:OF What, you may wonder, is this new entity? - Is it a corporation? No, not exactly. - Is it a partnership? Yes, sort of. - Is it a sole proprietorship? No, not quite. A number state legislatures around the U.S. in recent years have recently created a new type of entity called a "limit- ed liability company" (or LLC). These new entities, which closely resemble (and are taxed the same as) partnerships, offer limited liability, like corporations. While it has long been possible for a partnership to offer limited lia- bility to the LIMITED partners, a limited partnership must always have at least one GENERAL partner, who is fully liable for the debts of the business. The new "limited liability companies" have, in effect, done away with the need to have unlimited liability for any of the owners of what is, in essence, a partnership form of business organization. In 1988, in Revenue Ruling 88-76, the IRS concluded that a Wyoming limited liability company could be classified as a partnership for Federal income tax purposes (which is fav- orable, from the taxpayer's standpoint, in many cases), based on the following rationale: . No member has any personal liability for debts of the company; therefore the company has limited liability. (Like a corporation) . The interests of the members are assignable only upon written consent of all of the remaining members. (Like a partnership; however, the Ruling recognized that mere assignees are entitled to receive profits and other compensation.) . The company is dissolved in situations which are very similar to the dissolution of a limited partnership. (Like a partnership) . The company has centralized management. (Like a corporation) Under IRS criteria, any entity that has no more than two of the four above features of a corporation is not consid- ered to be a corporation. Thus because of the absence of "continuity of life" and "free transferability" of interests in the LLC entity, the Wyoming limited liability company was held to be a partnership for tax purposes. Florida has also recently adopted a Limited Liability Com- pany Act, which is virtually identical to that of Wyoming. However, for income tax purposes, Florida taxes LLC's as though they were corporations. In addition, in 1990, Colorado enacted legal provisions that permit the formation of "limited liability companies," which are not subject to income tax and are to be treated, for state tax purposes, as partnerships, but which have limited liability. The Colorado limited liability companies would also appear to meet the IRS tests for taxability as a partnership. Other states that have enacted "limited liability company" laws in recent years include Kansas, Nevada, Texas, Virginia, West Virginia, and Utah. Iowa has just recently adopted a limited liability company law, effective July 1, 1992; Louisiana, effective July 9, 1992; Oklahoma has enac- ted limited liability company provisions, effective as of September 1, 1992; Rhode Island, effective September 19, 1992; Arizona, effective September 30, 1992; Maryland and Delaware have done so, both effective as of October 1, 1992; Minnesota, effective January 1, 1993; and Illinois has also passed LLC legislation that will go into effect on January 1, 1994. Several other states have just adopted LLC pro- visions in 1993. In addition, the states of Tennessee and Indiana have enacted laws that recognize out-of-state LLC's and allow them to conduct business in the state, but neither of these states has, as yet, provided for LLC's to be formed under its own laws. California's Franchise Tax Board has also announced that it will follow the IRS tax treatment of LLC's formed in other states (generally, treating them as partnerships, rather than corporations, for tax purposes). LLC legislation is pending in Hawaii, Indiana, Missouri, Nebraska, Pennsylvania, South Carolina, and Tennessee. It is under consideration in California as well, but due to California's budget difficulties and the expected loss of $600 million in state tax revenues if LLC legislation is passed, California legislators are a bit hesitant about jumping on the LLC bandwagon at this point. @CODE: SD MT NB ND ID GA AR AL IN @STATE has recently (1993) adopted LLC legislation. @CODE:OF @CODE: MI Michigan has enacted an LLC law, which went into effect on June 1, 1993. @CODE:OF @CODE: AL MT The @STATE LLC law goes into effect on October 1, 1993. @CODE:OF @CODE: SD ND ID IN The @STATE LLC law went into effect on July 1, 1993. @CODE:OF @CODE: GA The Georgia LLC law becomes effective March 1, 1994. @CODE:OF @CODE: AR The Arkansas LLC law became effective April 12, 1993. @CODE:OF @CODE: NB Ther Nebraska LLC law goes into effect on September 9, 1993. @CODE:OF Major benefits of LLC's over the traditional business enti- ties available up till now include the following: . Unlike a general partnership, owners of an LLC have limited liability; and, unlike limited partners in a limited partnership, they do not lose their limited liability if they actively participate in management. . Like a regular corporation (a C corporation), an LLC provides limited liability to its owners, but taxable income or losses of the business will generally pass through to the owners (but may not always necessarily be deductible, due to the "at-risk" and "passive loss" limitations of the tax law). . An LLC is more like an S corporation, in that it pro- vides for a pass-through of taxable income or losses, as well as limited liability, but can qualify in many situations where an S corporation cannot, since an S corporation cannot: . have more than 35 shareholders; . have nonresident alien shareholders; . have corporations or partnerships as shareholders; . own 80% or more of the stock of another corpora- tion; . have more than one class of stock (or otherwise have disproportionate distributions); or . have too much of certain kinds of "net passive income." . Also, LLC owners may be able to claim tax losses in excess of their investment, such as on certain lever- aged real estate investments, which would not ordinar- ily be possible in the case of an S corporation or even a limited partnership. On the other hand, most of the LLC statutes have certain built-in disadvantages, as compared to S corporations or other corporations, such as the fact that LLC's must usual- ly provide in their articles of organization that the en- tity will terminate in not more than 30 years, and the fact that an LLC must have more than one owner, unlike corpora- tions. @CODE: AL AZ AR CO DE FL GA ID IL IN IA KS LA MD MN MT NB NV ND OK RI SD TX UT VA WV WY Perhaps the major drawback of an LLC formed in @STATE at present, however, is the uncertainty as to how it will be treated in other states that have not yet adopted LLC laws or recognized the LLC concept. Thus, if your LLC carries on business in another state, the other state you are doing business in may not recog- nize the limited liability feature of such an entity, which could be disastrous to the owners if your "limited liability" company were to go broke and the owners were treated like partners in a partnership (that is, fully liable) in the other state, rather than being accorded limited liability. Secondly, other states may not necessarily recognize your LLC formed outside their state as a partnership-like entity for tax purposes. This could also result in some serious tax traps, particularly if distributions by your LLC were taxed by such a state as corporate dividends, after it first subjected the LLC's earnings to a corporate-level state income tax. @CODE:OF @CODE: FL In fact, Florida itself treats LLC's as corporations for purposes of the Florida corporate income tax law, even though a Florida LLC is treated as a partnership for federal income tax purposes. (There is no individual income tax in Florida, so the income of an LLC would entirely escape state taxation if Florida did not tax its income at the entity level, which probably explains why the state of Florida chose not to follow the federal tax treatment in this case.) @CODE:OF Even so, LLC's seem to have many advantages that almost guarantee a boom in their popularity in coming years. This may be the first you have heard of Limited Liability Companies, but it certainly won't be the last. Remember, you heard it here first.... @CODE: AK CA CT DC HI KY ME MA MS MO NH NJ NM NY NC OH OR PA SC VT WA WS @CODE:NF This new entity may have possibilities for companies doing business outside the handful of states that have enacted limited liability company legislation so far. Just as com- panies in many parts of the country may choose to incor- porate in Delaware, or Nevada, or other states other than where they actually do business, it may also be possible in other states to "incorporate" under the Wyoming (or Florida, Colorado, etc.) limited liability company provi- sions. However, since this is a newly developing area of the law, you would be well advised to consult a competent business attorney to determine whether your firm will be able to take advantage of such an out-of-state entity's special benefits under the laws of @STATE. One potentially serious problem is that if you create an LLC under the "limited liability company" laws of, say, Wyoming, and carry on business in another state, the other state you are doing business in may not recognize the limited liabil- ity feature of such an entity, which could be disastrous to the owners if your "limited liability" company were to go broke and the owners were treated like partners in a part- nership (that is, fully liable) in the other state. Secondly, other states may not necessarily recognize your LLC formed outside the state as a partnership-like entity for tax purposes. This could also result in some serious tax traps, particularly if distributions by an LLC were taxed by such a state as corporate dividends, after it first subjected the LLC's earnings to a corporate-level state income tax. Thus, this entity may be best now only for firms that do business only within the state that authorizes the creation of the limited liability company, such as, for instance, Wyoming, for a company formed under the Wyoming limited liability company law, or in other states, like those lis- ted above, that recognize the LLC concept.