Until the emergence of the limited liability company, the limited part-nership was the refuge for businesses that wanted limited liability, pre-ferred partnership tax consequences over those of Subchapter S, or felt that the Subchapter S eligibility requirements were too constraining. But current thinking is that the limited partnership, though sometimes better than an S corporation, generally is inferior to a limited liability company.
It probably is, but hardly by a sufficient margin to justify the creation of a whole new area of business organization law.
While the limited partnership accords limited liability to the limited partners, the limited partnership must have at least one general partner who is personally liable for all the partnership debts.
5 6Moreover, limited partners can be reclassified as general partners, and thereby lose their limited liability, by participating too intrusively in the management of the partnership business.
57In contrast, limited liability companies have neither weakness. The codes creating limited liability companies give all of the owners (called "members") limited liability.
58Limited liability companies need not have a member with unlimited personal liability.
Also, their members are not punished for participating in the manage-ment of the business. In short, members are just like shareholders.
Members are not vicariously liable for the debts of the business merely by virtue of their status as owners, and they do not automatically lose this protection merely by managing the entity's affairs.
Yet the superiority of the limited liability company over the limited partnership is being exaggerated. It is common practice for a limited partnership to use a corporation as its general partner. This practice insu-lates the personal assets of the limited partners from potential seizure by a creditor of the partnership. The corporate general partner has unlim-ited liability, of course, but it need not have many assets.
Furthermore, the Revised Uniform Limited Partnership Act, adopted in 48 states and the District of Columbia,
5 9has greatly reduced the
56. UNip. LTD. PARTNERSHIP ACT §§ 1, 9 (1916); REVISED UNIF. LTD. PARTNERSHIP Acr §§ 101, 403 (1976) (amended 1985).
57. UNIF. LTD. PARTNERSHIP Acr § 7; REVISED UNIF. LTD. PARTNERSHIP Acr § 303.
58. See infra note 90 and accompanying text.
59. ALA. CODE §§ 10-9A-1 to -203 (Supp. 1994); ALASKA STAT. §§ 32.11.010-.990 (1993); ARIz. REv. STAT. ANN. §§ 29-301 to -366 (1989 & Supp. 1994); ARK. CODE ANN.
§§ 4-43-101 to -1109 (Michie 1991 & Supp. 1993); CAL. CORP. CODE §§ 15611-15723 (West 1991 & Supp. 1994); COLO. REv. STAT. ANN. §§ 7-62-101 to -1201 (West 1986 & Supp.
1994); CONN. GEN. STAT. ANN. §§ 34-9 to -381 (West 1987 & Supp. 1995); DEL. CODE ANN. tit. 6, §§ 17-101 to -1109 (1993 & Supp. 1994); D.C. CODE ANN. §§ 41-401 to -499.25 (1990 & Supp. 1994); FLA. STAT. ANN. §§ 620.101-.192 (West 1993 & Supp. 1995); GA.
CODE ANN. §§ 14-9-100 to -1204 (1994); HAW. REV. STAT. §§ 425D-101 to -1108 (1993 &
Supp. 1994); IDAHO CODE §§ 53-201 to -268 (1994); ILL. ANN. STAT. ch. 805, para 210/100 to 210/1205 (Smith-Hurd 1993 & Supp. 1995); IND. CODE ANN. §§ 23-16-1-1 to -16-12-6 (Burns 1995); IowA CODE ANN. §§ 487.101-.1105 (West Supp. 1994); KAN. STAT. ANN.
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probability that a limited partner will be classified as a general partner
merely by participating in the partnership's business. According to the Act, a limited partner, without fear of being reclassified as a general part-ner, may act as an agent, employee, contractor, or advisor to either the limited partnership or the general partner.
60Some writers still argue that corporate general partners do not
ade-quately protect the personal assets of the limited partners, because a court might pierce the corporate veil of the general partner to make themindividually liable, especially if the general partner is inadequately capi-talized.
61Certainly, this is not an absolute impossibility, but it sounds
Limited Liability Companies, 27 CREIGrHTON L. REV. 191,208 (1993); see also John J. Rati-gan, Comment, Piercing the Veil of the Corporate General Partner in the Hybrid Limited Partnership: A Suggestive Remedy for Inequitable Conduct by Limited Partners, 17
SUF-FOLK U. L. REv. 949 (1983) (arguing that courts should pierce the corporate veils of thinly capitalized corporate general partners of limited partnerships).
62. A computer search produced only a few cases involving attempts to pierce the corporate veil of a corporate general partner. While the courts seemed willing to do so under appropriate circumstances, plaintiffs often failed to satisfy the requirements for piercing the veil. See, e.g., Mid Kansas Fed. Sav. & Loan Ass'n v. Orpheum Theater Co., 810 F. Supp. 1184, 1195 (D. Kan. 1992) (not enough facts to complete the piercing analysis, and piercing denied); In re City Communications, Ltd. v. Knobloch, 105 B.R. 1018, 1022-23 (Bankr. N.D. Ga. 1989) (bankruptcy trustee permitted to pursue an alter ego claim against the owners of debtor's general partner); Butler v. Collins, 14 B.R. 546, 548 (Bankr. E.D.
La. 1981) (producer hired by the corporate general partner was unable to pierce the corpo-rate veil to recover money owed to him); Western Camps, Inc. v. Riverway Ranch Enters., 138 Cal. Rptr. 918, 927 (Cal. Ct. App. 1977) (court held that the corporate general partner was solely liable for the obligations of the limited partnership, where the creditor was
SMU LAW REVIEW
extreme reluctance to pierce the corporate veil merely because of inade-quate capitalization.63 Lastly, it seems likely that a court would pierce
the veil of a limited liability company just as readily as it would pierce the veil of a corporation.
64Moreover, the owners of a closely held venture can never be assured of absolute limited liability. Factually, the distinctions with respect to lim-ited liability between the different forms of business organization are not nearly as dramatic in practice as they are in theory.
65The members of a limited liability company and shareholders may theoretically have limited liability, but if they seek to obtain credit for their businesses, the putative lender is likely to require personal guarantees from the members just like the lender would from shareholders in a closely held corporation. The
concept of limited liability also does not insulate shareholders, members,or anyone else from personal liabilities for any torts that they themselves
commit while working for the business. Conversely, proprietors and gen-eral partners sometimes can avoid personal liabilities to contract creditorsthrough a provision in the contract (e.g., using nonrecourse instead of
aware of the corporate status of the general partner and the corporation was "organized in good faith and had an adequate capitalization necessary to liquidate its indebtedness"). In Pearl v. Shore, 95 Cal. Rptr. 157, 161-63 (Cal. Ct. App. 1971), the court refused to pierce the veil of the corporate general partner to allow recovery by a limited partner. The court disregarded the plaintiff's undercapitalization argument since the corporation was capital-ized with $100,000. The court also indicated that the failure of the business had to do with poor management and not initial undercapitalization. Id. See also Star Video Entertain-ment L.P. v. Video USA Ass'n, 601 A.2d 724, 727 (N.J. Super. Ct. App. Div. 1992) (per-sonal jurisdiction granted over the corporate general partners and their principals and directors on the basis of an alter ego theory); In re Estate of Hall, 535 A.2d 47, 54-55 (Pa. affairs were kept separate from the affairs of the corporation, the separate corporate entity should be respected).
64. Steven C. Bahls, Application of Corporate Common Law Doctrines to Limited Lia-bility Companies, 55 MONT. L. REV. 43, 60-66 (1994). Professor Bahls discusses the appli-cation of the doctrine of piercing the corporate veil to limited liability companies. Noting that some commentators have reserved judgment as to whether courts should apply the corporate standards for piercing the corporate veil to limited liability companies, Professor Bahls states that others have argued that the corporate standard should apply. The author would allow for piercing the veil of the limited liability company, but with some differences in rules to accommodate the differences between corporations and limited liability compa-nies. Professor Bahls uses the Colorado limited liability statute, which directs the courts to apply the case law for piercing the corporate veil to piercing the veil of limited liability
PASSTHROUGH ENTITIES
recourse debt) in addition to limiting their individual tort liability by
tak-ing out liability insurance. Finally, the corporate shield (and presumably
the limited liability company shield)66 is not impenetrable. The volumi-nous case law in piecing the corporate veil clearly demonstrates this fact.Does the limited liability company provide better protection against per-sonal liability than the limited partnership? Yes, but not by much.
B. PASSIVE AcrivITY Loss LIMITATIONS
An unsettled issue is the application of the passive activity loss limita-tions to the members of limited liability companies. S corporation share-holders and both general and limited partners can run afoul of the section 469 strictures, but the regulations67 are the toughest on limited partners.68 The taxpayer can avoid application of the passive activity loss limitation by materially participating in the activity.69 For most taxpayers, the regu-lations provide that a taxpayer can be deemed to participate materially in an activity by satisfying any one of seven alternative tests.70 For example, the taxpayer materially participates if his or her participation in the activ-ity for the taxable year constitutes substantially all of the participation in the activity for such taxable year.7 1 But for a limited partner to partici-pate materially, that partner must meet one of three "stricter" tests, each of which requires the limited partner to participate in the activity for more than five hundred hours in a year.72
Members of a limited liability company, then, would prefer to be classi-fied as general partners rather than as limited partners, but the language of the current regulation seems to require the members to be treated under the tougher rules applicable to limited partners.7 3 This is because the definition in the regulation focuses on a taxpayer's limited liability,74 and limited liability company members have limited liability.75 Except for limited liability, members probably have more in common with gen-eral partners; like gengen-eral partners, members are vested with managerial powers, and they run the business. This sounds like material participa-tion, and if the regulations are revised, it might well be that members are treated as general partners.76 This would remove what might be a current disadvantage for the limited liability company.
66. See Bahls, supra note 64, at 60-67.
67. See Temp. Treas. Reg. §§ 1.469-5T(e), 1.469-5T(a)(1)-(3) (1988).
68. See An Interview With Susan Pace Hamill, 72 TAxES 327, 328 (1994); Vitek, supra note 61, at 234-35.
69. I.R.C. § 469(c)(1)(B); Temp. Treas. Reg. § 1.469-5T.
70. Temp. Treas. Reg. § 1.469-5T(a)(1)-(7).
71. Id § 1.469-5T(a)(2).
72. See, e.g., Temp. Treas. Reg. § 1.469-5T(e)(2); David C. Culpepper, Tax Aspects of Limited Liability Companies, 73 OR. L. REv. 5, 21 (1994); Vitek, supra note 61, at 235.
73. Temp. freas. Reg. § 1.469-5T(e)(3).
74. Id
75. An Interview With Susan Pace Hamill, supra note 68, at 328-29.
76. Id.; see also Culpepper, supra note 72, at 21.
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V. TAX LAW BY SELF-HELP: THE EXAMPLE OF THE MASTER LIMITED PARTNERSHIP
Many of the best tax advisors are crafty. If they do not find the desired mix of tax and nontax features on the current menu of available business organization forms, they will construct a new form. Actually, the term
"new form" is an exaggeration. What they really do is reshuffle the char-acteristics of current business forms to construct a hybrid entity that has as its characteristics features of the preexisting types. In essence, this is a type of self-help by the private-sector tax specialists. Dissatisfied with what federal or state law offers, they use their ingenuity to develop a more suitable form.
The emergence of master limited partnerships presents one such exam-ple of self-help.77 Partnerships never have suffered the C corporation dis-advantage of double taxation of distributed earnings, but this dis-advantage was tempered by the historically higher marginal tax rates for individuals over C corporations. But Congress closed the gap between the C corpo-ration and individual rates in 1982 and actually inverted them in 1986, making the highest rate for C corporations higher than the highest indi-vidual rate for the first time in history.78 As a consequence, partnerships not only avoided the C corporation disadvantage of double taxation, but often provided a lower rate of taxation on the entity-level earnings.
While partnership tax consequences had always been good for enterprises that produced tax losses, they now were good for prosperous enterprises as well.79 Moreover, although under the Kintner Regulations80 the pub-licly traded limited partnership was classified as a partnership for tax pur-poses, in real life the entity had the nontax advantages associated with a corporation. The limited partners were essentially no different than shareholders. They traded their partnership interests on the public ex-changes as if they were shares of stock.8' They had limited liability and benefited from centralized management in the form of a general partner.
They were not saddled with managerial responsibilities and accompany-ing fiduciary duties.82 Thus, the master limited partnership possessed all of the nontax benefits usually associated with a corporate form, and in addition offered lower tax rates and no double tax on distributed earnings.
The allure of the master limited partnership seemed almost irresistible, but Congress quickly responded to this self-help corporate integration.8 3
77. Master limited partnerships are sometimes referred to as publicly traded limited partnerships. For a general discussion of the history of master limited partnerships, see Marvin F. Milich, Master Limited Partnerships, 20 REAL EST. L.J. 54 (1991).
78. See id. at 61.
79. Id.
80. Treas. Reg. § 301.7701-2 (as amended in 1993).
81. Milich, supra note 77, at 55.
82. Id. at 58.
83. See I.R.C. § 7704 (1988). Congress enacted § 7704 in the Omnibus Budget Recon-ciliation Act of 1987, Pub. L. No. 100-203, § 10211, 101 Stat. 1330-403 (1987). The statute also enacted I.R.C. § 469(k) (1988 & Supp. V 1993), which applies the passive loss rules to [Vol. 49
PASSTHROUGH ENTITIES
Congress feared that the irresistibility of publicly traded partnerships
would result in a disincorporation of America.8 Congress was also con-cerned that, since the nontax attributes were basically the same as those of a corporation but entailed better tax consequences, virtually all
pub-licly traded entities would transpose themselves into master limited part-nerships.85 That transposition, it was feared, would destroy the corporateincome tax and result in a devastating loss of Treasury revenue.
86Ac-cordingly, in 1987 Congress hastily enacted section
7704.87This section requires publicly traded limited partnerships to be treated as C corpora-tions for federal income tax purposes,
88thereby thwarting the private sec-tor effort at self-help.
VI. LIMITED LIABILITY COMPANIES
A.
THE LATEST FORM OF SELF-HELP: BAD FORMATION OF TAX LAWLimited liability companies are the hottest phenomenon in the legal community. Not wanting to be left behind,89 virtually every state has en-acted legislation that authorizes their creation.90 They are made the
sub-master limited partnerships, and I.R.C. § 512(c)(2) (Supp. V 1993), which provides that tax-exempt organizations that invest in master limited partnerships must treat their share of income as derived from an unrelated trade or business.
84. H.R. REP. No. 391, 100th Cong., 1st Sess. 1065 (1987), reprinted in 1987 U.S.C.C.A.N. 1,680.
85. Milich, supra note 76, at 63.
86. Id.
87. Omnibus Budget Reconciliation Act of 1987, § 10211, 101 Stat. 1330-403 (codified at I.R.C. § 7704 (1988)).
88. Id.
89. Referring to the enactment of limited liability company legislation in Oregon, one writer stated: "Oregon's ability to attract and retain foreign business will be adversely af-fected until such legislation is enacted. Oregon's need to remain in the forefront of new and emerging trends and developments similarly will require that we legislatively provide for the creation and operation of LLCs." Donald W. Douglas & David C. Culpepper, OR.
ST. BAR BULL., Dec. 1992, at 11, quoted in David L. Cameron, Strike Up the Band: The Limited Liability Company Comes to Oregon, 30 WILLAmTrE L. REV. 291, 295 n.11 (1994).
90. See ALA. CODE §§ 10-12-1 to -61 (Supp. 1994); ALASKA STAT. §§ 10.50.010-.995 (Supp. 1994); ARIz. REv. STAT. ANN. §§ 29-601 to 801-857 (1992); ARK. CODE ANN. §§ 4-32-102 to -1316 (Michie Supp. 1994); 1994 Cal. Legis. Serv. ch. 1200 (West); COLO. REV.
STAT. §§ 7-80-101 to -913 (Supp. 1992); 1993 Conn. Legis. Serv. P.A. 93-267 (West); DEL.
CODE ANN. tit. 6, §§ 18-101 to -1106 (1992); 1994 D.C. Stat. 10-138; FLA. STAT. ANN.
§§ 608.401-.471 (West 1992); GA. CODE ANN. §§ 14-11-100 to -1109 (Harrison 1993);
IDAHO CODE §§ 53-601 to -672 (1993); ILL. ANN. STAT. ch. 805, para. 180/1-1 to 180/60-1 (Smith-Hurd 1993); IND. CODE ANN. §§ 23-18-1-1 to -13-1 (Bums Supp. 1994); IOWA
CODE §§ 490A.100-.1601 (1993); KAN. STAT. ANN. §§ 17-7601 to -1652 (Supp. 1992); .KY.
REV. STAT. ANN. §§ 275.001-.455 (Michie/Bobbs-Merrill 1994); LA. REv. STAT. ANN.
§§ 12:1301-:1369 (West 1993); ME. REv. STAT. ANN. tit. 31, §§ 601-762 (West 1994); MD.
CODE ANN., CORPS. & Ass'NS §§ 4A-101 to -1103 (1992); 1994 MASS. S.B. No. 72; 1994
MASS. H.B. 1798; MIcH. CoM. LAWS ANN. §§ 450.4101-.5200 (West 1993); MirNm. STAT.
§§ 322B.01-.955 (1993); 1994 Miss. LAWS ch. 402; Mo. ANN. STAT. §§ 347.010-.735 (Vernon 1994); MONT. CODE ANN. §§ 35-8-101 to -1307 (1994); NEB. REv. STAT. §§ 21-2601 to -2645 (Supp. 1993); NEV. REv. STAT. ANN. §§ 86.011-.571 (Michie Supp. 1991); N.H. REV.
STAT. ANN. §§ 304-C:1 to -D:20 (1994); N.J. STAT. ANN. §§ 42:2B-1 to -70 (West 1994);
N.M. STAT. ANN. §§ 53-19-1 to -74 (Michie 1993); 1994 N.Y. Laws ch. 576; N.C. GEN.
STAT. §§ 57C-1-01 to -19-07 (1994); N.D. CENT. CODE §§ 10-32-01 to -155 (Supp. 1993);
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30 SMU LAW REVIEW [Vol. 49
91. See, e.g., Scott R. Anderson, The Illinois Limited Liability Company: A Flexible Alternative for Business, 25 Loy. U. Cm. L.J. 55, 108 (1993) ("the most advantageous alter-native for many businesses"); Bahlis, supra note 64, at 44 (limited liability company as an
"evolutionary entity ... promises simplicity in formation, flexibility in planning and opera-tion, limited liability, member control of the business, and significant tax advantages when compared with corporations ... almost uniform praise for limited liability companies...
the most significant national development in the law of closely owned business organiza-tions in decades"); Marybeth Bosko, The Best of Both Worlds: The Limited Liability Com-pany, 54 OHio ST. L.J. 175, 175 (1993) ("perhaps the most innovative form of business
association"); Jerome Kurtz, The Limited Liability Company and the Future of Business Taxation: A Comment on Professor Berger's Plan, 47 TAX L. REV. 815, 818 (1992) ("[t]his is tax Nirvana"); Bradley J. Sklar & W. Todd Carlisle, The Alabama Limited Liability Company Act, 45 ALA. L. REV. 145, 147 (1993) ("the business entity of choice"); Richard Johnson, Comment, The Limited Liability Company Act, 11 FLA. ST. U. L. REV. 387, 388 (1983) ("the advantages .. .appear to be substantial"); Robert G. Lang, Note, Utah's Limited Liability Company Act: Viable Alternative or Trap for the Unwary?, 1993 UTAH L.
REV. 941, 970 ("an exciting new entity"); Jimmy G. McLaughlin, Commentary, The Lim-ited Liability Company: A Prime Choice for Professionals, 45 ALA. L. REV. 231,245 (1993) ("a practical alternative to both the professional corporation and the general partnership by combining some of the best characteristics of each").
92. See, e.g., Anderson, supra note 91; May B. Bader, Organization, Operation, and Termination of North Dakota and Minnesota Limited Liability Companies, 70 N.D. L. REV.
585 (1994); Bosko, supra note 91; Frank M. Burke Jr. & John S. Sessions, The Wyoming Limited Liability Company: An Alternative to Sub S and Limited Partnership?, 54 J. TAX'N 232 (1991); David C. Culpepper, Symposium on Oregon's Limited Liability Company Act:
Tax Aspects of Limited Liability Companies, 73 OR. L. REv. 5 (1994); S. Brian Farmer &
Louis A. Mezzullo, The Virginia Limited Liability Company Act, 25 U. RicH. L. REV. 789 (1991); Mark Golding, Symposium on Oregon's Limited Liability Company Act: Tax As-pects of Converting a Partnership or Corporation into an Oregon Limited Liability Com-pany, 73 OR. L. REV. 25 (1994); Mark Golding, Symposium on Oregon's Limited Liability Company Act: Financial Aspects of Oregon Limited Liability Companies, 73 OR. L. REV.
55 (1994); Tanya Hanson, Symposium on Oregon's Limited Liability Company Act: A Sum-mary of Fiduciary Duty Rules Under the Oregon Limited Liability Company Act, 73 OR. L.
REV. 129 (1994); Patrick J.S. Inouye, Symposium on Oregon's Limited Liability Company Act: A Comparative Look at Oregon's Limited Liability Company Act, 73 OR. L. REv. 133 (1994); John D. Jackson & Alan W. Tompkins, Corporations and Limited Liability Compa-nies, 47 SMU L. REv. 901 (1994); David Kopilak, Symposium on Oregon's Limited Liabil-ity Company Act: An Articles of Organization and Operating Agreement Checklist for Oregon Limited Liability Companies, 73 OR. L. REV. 151 (1994); Kurtz, supra note 91;
Stuart Levine & Marshall B. Paul, Limited Liability Company Statutes: The New Wave, 4 J.
CORP. TAX'N 226 (1993); Saul Levmore, Partnerships, Limited Liability Companies, and Taxes: A Comment on the Survival of Organizational Forms, 70 WASH. U. L.Q. 489 (1992);
John G. Martel, Symposium on Oregon's Limited Liability Company Act: Default Fiduci-ary Duty Rules Under Oregon's Limited Liability Company Act, 73 OR. L. REV. 121 (1994);
Mary E. Matthews, The Arkansas Limited Liability Company: A New Business Entity is Born, 46 ARK. L. REV. 791 (1994); Erich W. Merrill, Jr., Symposium on Oregon's Limited Liability Company Act: Treatment of Oregon Limited Liability Companies in States With-out Limited Liability Company Statutes, 73 OR. L. REv. 43 (1994); Sandra K. Miller, What Standards of Conduct Should Apply to Members and Managers of Limited Liability Com-panies?, 68 ST. JOHN'S L. REV. 21 (1994); Charles R. O'Kelly, Symposium on Oregon's Limited Liability Company Act. Foreword- Understanding the Place of Limited Liability
1995] PASSTHROUGH ENTITIES 31 continuing legal education presentations, and made the subject of new
"how-to" treatises.9 3 Their brief history resembles that of the master
lim-Companies in the Spectrum of Business Forms, 73 OR. L. REV. 1 (1994); Garry A. Pearson, The North Dakota Limited Liability Company Act: Formation and Tax Consequences, 70 N.D. L. REv. 67 (1994); H. Edward Phillips, III, The Proposed Tennessee Limited Liability Company Act, 24 MEM. ST. U. L. REv. 491 (1994); Matthew W. Ray, The Texas Limited Liability Company-A Possible Alternative for Business Formation, 46 SMU L. REV. 841
lim-Companies in the Spectrum of Business Forms, 73 OR. L. REV. 1 (1994); Garry A. Pearson, The North Dakota Limited Liability Company Act: Formation and Tax Consequences, 70 N.D. L. REv. 67 (1994); H. Edward Phillips, III, The Proposed Tennessee Limited Liability Company Act, 24 MEM. ST. U. L. REv. 491 (1994); Matthew W. Ray, The Texas Limited Liability Company-A Possible Alternative for Business Formation, 46 SMU L. REV. 841