Conducting a tax practice in the 1990s.

• Author: Pascarella, Stephen E., II

Recently, the AICPA membership voted to change rule 505 of the Code of Professional Conduct. The new rule now allows members to practice in any form of organization permitted by state law or regulation.

The new rule 505 reads in part as follows:

A member may practice public accounting only in a form of organization permitted by state law or regulation whose characteristics conform to resolutions of council.

This recent change to rule 505 has caused an increased interest in limited liability companies (LLCs) as a new organizational form for CPAs, as the LLC combines liability protection at the state level with favorable tax treatment at the Federal level. Because the IRS has ruled that LLCs may be treated as partnerships for Federal tax purposes, this gives members the benefits and flexibility of partnership taxation on without all the headaches associated with limited partnerships.

However, in order to achieve partnership tax status under Federal law, any LLC must qualify under the provisions of the Internal Revenue Code and regulations applicable to classification of business entities. The Internal Revenue Code lists four features that must be examined in classifying a business organization. Any entity seeking partnership treatment for tax purposes may have no more than two of these features. 1. Limited liability. 2. Free transferability of interests. 3. Continuity of life. 4. Centralized management.

So far, there have been two types of LLC laws passed by states: the bulletproof and the flexible. Under the bulletproof law, an LLC has limited liability for its members and may permit centralized management, but generally cannot have continuity of life or transferability of interest. Under the flexible law, an LLC has limited liability for its members and permits any one of the other features.

There still exists some uncertainty regarding how LLCs will be treated among the various states. While only a small number of states allow LLCs (see LLC Update below), the laws differ from state to state. For example, in Colorado, an LLC is treated as a partnership for state tax purposes if it qualifies as a partnership for Federal tax purposes. However, in Florida, LLCs are treated as C corporations for state tax purposes even though they qualify as partnerships for Federal tax purposes. In addition, it is also unclear whether states other than the state in...