Utah Limited Liability Companies: The ''Ugly Ducklings"

I. INTRODUCTION When forming a new business entity, people generally choose between a partnership and a corporation.(1) For small companies, however, these alternatives may not be attractive. If a small company chooses to incorporate, double taxation and adherence to corporate formalities may be cumbersome. On the other hand, potential liability of a partnership may be cost-prohibitive. Fortunately, there is a third alternative--a limited-liability company (LLC).(2) An LLC "can be described as a business form much like a partnership, complete with partnership tax advantages, yet providing liability protection for its members similar to that provided by a corporation."(3) Wyoming, in 1977, was the first state to enact legislation creating LLCs.(4) However, other states have been reluctant to create LLCs due primarily to the uncertainty of whether LLCs would actually be given the tax advantages of a partnership and the liability protection of a corporation. But in September of 1988, the Internal Revenue Service (IRS) published Revenue Ruling 88-76,(5) which "classified an unincorporated organization operating under the Wyoming Limited Liability Company Act as a partnership for federal income tax purposes."(6) With this Ruling in mind, several states cautiously passed legislation allowing for the establishment of LLCs, including Arizona,(7) Colorado,(8) Florida,(9) Kansas,(10) Maryland,(11) Nevada,(12) Texas,(13) Utah,(14) and Virginia.(15) Bills to create LLCs have been introduced in Illinois,(16) Michigan,(17) Oklahoma,(18) and Pennsylvania.(19) However, it is still unclear whether other states will recognize the limited liability of LLCs; without such protection, the advantage of LLCs is substantially diminished. This comment examines Utah LLCs in more detail, focusing primarily on their partnership tax advantages and limited liability protection. Part II discusses the characteristics LLCs must possess in order to qualify for partnership tax advantages. Part III analyzes more thoroughly the limited liability aspect of LLCs, focusing on the anticipated recognition of limited liability in other states. Finally, part IV concludes that LLCs should enjoy limited liability protection in other states unless prohibited by public policies or statutes. II. CHARACTERISTICS OF LLCS FOR TAX PURPOSES According to Revenue Ruling 88-76, whether a particular organization qualifies as a partnership for federal taxation purposes depends on whether it possesses more corporate or noncorporate characteristics.(20) The four relevant corporate characteristics, as set forth in 26 C.F.R. Sec 301.7701-2(a)(1), are continuity of life, centralization of management, free transferability of interests, and limited liability.(21) According to Revenue Ruling 88-76, if a business organization contains fewer than three of these four corporate characteristics, it will be classified as a partnership for tax purposes. The following sections analyze each of the four corporate characteristics under Utah's limited liability company statute. A. CONTINUITY OF LIFE According to 26 C.F.R. Sec 301.7701-2(b)(1), continuity of life does not exist if an organization will dissolve upon the death, insanity, bankruptcy, retirement, resignation, or expulsion of any member. Utah's Limited Liability Company Act provides that an LLC shall be terminated (1) upon the expiration of a fixed period of time if so provided in the articles of organization or the operating agreement;(22) (2) by written agreement of the members of the LLC entitled to receive a majority of the profits, unless otherwise provided by the operating agreement;(23) (3) by the "death, retirement, resignation, expulsion, bankruptcy, or dissolution of a member or upon the occurrence of any other event that terminates the continued eligibility for membership of a member in the limited liability company";(24) or (4) when the LLC is not a successor of two or more merged LLCs. …