North Carolina's new and improved LLC law.

• Author: Davis, W.B. Rodman
• Position: Limited liability companies - Column

By now, most North Carolina business people are familiar with limited-liability companies. The rapid acceptance of this new form of business organization is due in large part to the LLC's flexible nature. An LLC can be adapted to the specific needs of almost any business arrangement while achieving efficient tax characteristics and limited liability for all owners.

North Carolina LLCs came into existence in 1993, when the General Assembly enacted the original version of the state's Limited Liability Company Act. LLCs were perceived as a hybrid between a partnership and a corporation. Now, they have a unique reputation of their own. Even though the LLC Act was drafted by lawyers, it is written in an accessible, "plain English" style -- which has been reviewed favorably by business people as being understandable and straightforward. For instance, an LLC's owners are called members, and the persons responsible for the management of the LLC are called managers. The agreement governing the internal operations of an LLC is called an operating agreement.

Much of the structure of the original act was based on the idea that the statute's default rules should ensure that an LLC would qualify as a partnership for income-tax purposes under the existing federal classification rules. For instance, two members were required to form an LLC, and those default provisions limited transferability of a member's interest, avoided centralized management and prevented continuity of life to meet the federal rules' requirements for being treated as a partnership. By virtue of partnership classification, the entity's income subject to federal and state taxes flows through to the "partners" and is reported by them on their income-tax returns. This results in only one level of income taxation, as opposed to corporate income taxation, which often subjects income to two levels of taxation. To override the original act's default rules and achieve corporate tax status required a written operating agreement modifying the default rules -- presumably an intentional act on the founders' part.

In late 1996, the Internal Revenue System adopted new, user-friendly regulations for entity classification known as the "check-the-box regulations." Under them a two-member LLC (or other unincorporated entity) is automatically treated as a partnership and a one-member LLC is disregarded for federal tax purposes. A disregarded entity is treated as a sole proprietorship if its member is an...