How to ensure partnership tax treatment for an LLC.

• Author: McKinney, Hal, Jr.
• Position: Limited liability company

Limited liability companies (LLCs) have been around for years. Of late they have become more prominent, due mainly to recent state law changes allowing them to be formed in more places, and clarifying how they will fare legally in places other than where they were formed. At present, 47 or 48 states--including all of the most populous ones--allow or are on the verge of allowing formation of LLCs. For various reasons, the LLC may well be the entity of choice for starting a business in future years. Most reasons center around concepts such as "taxed like a partnership," "full owner liability shield" and "easy to form and flexible to operate."

A central LLC concern has been ensuring that the entity will indeed be "taxed like a partnership." In the past, the IRS has issued a pastiche of rulings detailing under what circumstances LLCs formed under a handful of individual state statutes would get partnership treatment. Now, with the rash of new laws, the Service has changed its strategy, and issued Rev. Proc. 95-10, to prescribe guidelines under which it will rule that an LLC formed under any state (or even presumably foreign) statute will be taxed as a partnership.

Before launching into the details of Rev. Proc. 95-10, it might be helpful to focus on the meaning of a few LLC "buzz words."

* The major permanent documents of an LLC are its articles of organization, which primarily give notice of its existence, and its operating agreement, which functions like a partnership agreement to define the business relationships of the owners (called members) and the way the entity will be run.

* State LLC statutes fall into two major categories: (1) "flexible" or "default" and (2) "bulletproof." The former provide various options for the provisions of the LLC operating agreement, with default provisions of law that will apply in places where the operating agreement is silent. Bulletproof statutes are those that provide little flexibility, but at the same time guarantee certain tax results. Since most state statutes are flexible, most attorneys tend to form LLCs in flexible-statute states, and to provide to various degrees for specific options to prevent application of undesirable legal default provisions. The result is that most operating agreements are detailed and voluminous.

* LLCs must elect under most (if not all) state statutes to be "member-managed" or "manager-managed." In the former case, all members act as managers to some extent--much like the...