Recent developments in LLCs.

• Author: Lux, Michael
• Position: Limited liability companies

LLC characteristics

The main reasons for using the limited liability company (LLC) form of business organization are its limited liability, its flexibility and its treatment as a partnership for tax purposes, with all of the income, deductions, credits, gains and losses flowing through to the owners. For it to be characterized as a partnership, rather than as an association taxable as a corporation, an LLC must lack at least two of these four important corporate characteristics: (1) limited liability, (2) continuity of life, (3) free transferability of interest and (4) centralization of management. Generally (but not always), an LLC will lack continuity of life and free transferability of interests. The absence of these two corporate characteristics will allow the LLC to be treated as a partnership for tax purposes. It is also possible for an LLC to lack centralization of management, depending on the LLC's operating agreement. The LLC by definition will possess limited liability.

LLC with one member or

related members

Texas appears to be the only state that permits an LLC to have only one member, in that it provides for continuation of the LLC even if only one member remains. The IRS has approved as a partnership a Texas LLC with two or more members, but it is still studying the issue of a one-member LLC.

An alternative to a one-member LLC is a two-member LLC, with the second member being a related family member or an affiliated or wholly owned corporation. However, there may be a problem with both these types of LLCs, as there are arguably no separate economic interests that could vote not to (1) continue the LLC if the sole or related member withdraws or (2) permit substitution of the buyer for the seller as a member if the sole or related member wants to sell its interest The Service may argue that the characteristics of continuity of life and free transferability are present, which could cause the LLC to be treated as a corporation. However, it is questionable whether this argument can be applied against a related family member who is a valid LLC member under state law.

The IRS recently ruled (in Rev. Rul. 93-4) that the single economic interest theory may not apply to continuity of life, and it may not apply to free transferability if transfers are prohibited in the LLC's operating agreement. One way to avoid this problem is for the operating agreement to provide for at least two unrelated members at all times.

De facto integration

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