Paul L. Caron

Tuesday, February 15, 2022

Hamill: Some Musings As LLCs Approach The Fifty-Year Milestone

Susan Pace Hamill (Alabama), Some Musings As LLCs Approach The Fifty-Year Milestone, 51 Cumb. L. Rev. __ (2022):

In less than twenty years, limited liability companies, or LLCs, became the fastest growing business organization form in the United States and indisputably emerged in the mainstream alongside corporations and partnerships.  In 2017, the most recent year for which IRS Statistics of Income figures were available, 2,696,149 LLCs filed returns with the Internal Revenue Service (the “IRS”).  This number represents well over three times the number of LLCs that filed returns in 2000.  In 2017, over one-fourth of the more than ten million total business organizations were LLCs, an impressive increase when compared to LLCs accounting for 10% of all business organizations in 2000.  Over this period, general and limited partnerships became less significant.  Although corporations still accounted for the majority of business organizations filings in 2017, the percentage of business organizations filing as corporations dropped by almost 10% when compared to the 2000 filings, and many of those businesses chose to become corporations before LLCs became widely available and are now stuck there—a situation I describe as the “Hotel California effect.”  These figures, along with the explosive growth of LLCs compared to an overall decrease of corporations, predict that the gap between the number of businesses conducted as corporations and LLCs will continue to close in the future.

Primarily aimed at readers who are not experts, this article identifies what makes LLCs so special and how they traveled from obscurity to the mainstream so quickly.  It also highlights business law issues and abusive practices exposed by the current use of LLCs and explains why these problems are not caused by LLCs.  Finally, this article demystifies the challenges of teaching and understanding LLCs within the framework of all business organizations.

Simply put, LLCs are the first domestic business organization form to combine direct corporate limited liability and partnership tax status.  The LLC’s creation and characteristics can be best understood as a dance between state and federal law.  Despite broad federal power under the Commerce Clause and business being a quintessential example of interstate commerce, state law authorizes business organization forms and dictates the provisions in each business organization statute, and state courts interpret those laws.  When determining the federal income tax consequences to the business organization and its owners, federal tax law largely yields to state law, notwithstanding the spirit of the Supremacy Clause.  Business organizations designated by state law as corporations are taxed at both the entity and shareholder levels or, if the corporation qualifies for and properly elects to be taxed as a small business corporation, at the shareholder level under a modified flow-through regime with many restrictions.  Business organizations designated by state law as “unincorporated,” including partnerships and LLCs, are almost always taxed as partnerships under a complete flow-through regime free of the many traps that plague corporations.

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