DP Tool Club 12/CD_ASCQ_12_0294.iso/vrac/sba93_4b.zip/F406.SBE

Text File | 1993-10-01 | 14KB | 343 lines

@222 CHAP 2

        ┌────────────────────────────────────────────────┐
        │Limited Liability Companies--A New Fourth Choice│
        └────────────────────────────────────────────────┘

@Q      "You can't use tact with a Congressman.  A
@Q       Congressman is a hog.  You must take a stick and
@Q       hit him on the snout."  -- Henry Adams

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 CT DE FL GA ID IL IN IA KS LA MD MI MN MO MT NB NH NJ NV NM NC ND OK OR RI SD TX UT VA WV WY
@STATE is one of the states that has enacted an "LLC"
law.
@CODE:OF

Unfortunately, the tax benefits that result from operating
as an LLC have already gotten the attention of Congress, and
a tax-writing committee is said to be looking into the possi-
bility of taking away the favorable tax treatment of LLCs, by
making them taxable as corporations.  So be forewarned that
the tax benefits of organizing as an LLC may be taken away
by Congress someday, if LLCs become too popular.

     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 usually taxed 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.

        ┌────────────────────────────────────────────────┐
        │WARNING:  Merely hiring an attorney to set up an│
        │LLC will not, in many cases, guarantee that your│
        │LLC will be taxed as a partnership, rather than │
        │as a corporation.  Accordingly, if you set up an│
        │LLC in any state, make sure you have a good tax │
        │adviser who can review the organization papers, │
        │to ensure that the LLC is organized in a manner │
        │that meets IRS requirements for taxability as a │
        │partnership.  Otherwise, the attorney who draws │
        │up the papers, if not sophisticated in tax mat- │
        │ters, may unwittingly create an LLC that has too│
        │many corporate characteristics, so that it will │
        │be taxable as a corporation, totally defeating  │
        │your main intended purpose for creating an LLC. │
        └────────────────────────────────────────────────┘

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 Florida, 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 state of Tennessee has enacted laws that
recognize out-of-state LLC's and allow them to conduct
business in the state, but Tennessee has not, as yet, pro-
vided 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 currently pending in Massachusetts, New
York, Pennsylvania, and Wisconsin.  Such legislation 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 still seem a bit hesitant about jumping on the
LLC bandwagon at this point.

@CODE: CT SD MT NB NH NM NJ NC ND ID GA AR AL IN MO OR
@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 CT MT NC
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: NH
The @STATE LLC law went into effect on July 1, 1993.

Under the new New Hampshire LLC statute, limited liability
companies may be formed under New Hampshire law.

Domestic LLCs may be formed by two or more persons, by
executing an agreement between the members of the LLC and
the LLC.  The law allows formation of LLCs for general
business purposes and also permits their formation for
the purpose of rendering professional services, such as
legal, medical, accounting, architecture and engineering
services.

For tax purposes, LLCs are treated as partnerships under
New Hampshire law and, if properly structured, may also
qualify for partnership treatment for federal tax purposes.

Foreign LLCs (formed in another state) must register with
the secretary of state before doing business in the state

@CODE:OF
@CODE: GA
The Georgia LLC law becomes effective March 1, 1994.

@CODE:OF
@CODE: NJ
The New Jersey LLC law becomes effective 12-27-1993.

@CODE:OF
@CODE: AR
The Arkansas LLC law became effective April 12, 1993.

@CODE:OF
@CODE: NM
The New Mexico LLC law went into effect on June 18, 1993.

@CODE:OF
@CODE: NB
The Nebraska LLC law goes into effect on September 9, 1993.

@CODE:OF
@CODE: OR
The Oregon LLC law goes into effect on January 1, 1994.

@CODE:OF
@CODE: MO
The Missouri LLC law goes into effect on December 1, 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 CT DE FL GA ID IL IN IA KS LA MD MN MO MT NB NH NJ NV NM NC ND OK OR 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 DC HI KY ME MA MS NY OH 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.