THE LIMITED LIABILITY COMPANY

T

HE

L

IMITED

L

IABILITY

C

OMPANY

Contact us at (800) 440-4780 or www.jamespublishing.com

Phillip L. Jelsma

Pamela Everett Nollkamper

Edited by Adam Pringle Production by Adam Pringle and Amanda Winkler

Copyright © 2012 James Publishing, Inc. ISBN: 0-938065-64-5

This publication is intended to provide accurate and authoritative information about the subject matter cov-ered. It is sold with the understanding that the publisher does not render legal, accounting, or other professional services. If legal advice or other expert assistance is required, seek the services of a competent professional.

Persons using this publication in dealing with specific legal matters should exercise their own independent judgment and research original sources of authority and local court rules.

The publisher and the authors make no representations concerning the contents of this publication and dis-claim any warranties of merchantability or fitness for a particular purpose.

We view the publication of this work as the beginning of a dialogue with our readers. Periodic revisions to it will give us the opportunity to incorporate your suggested changes. Call us at (714) 755-5450 or send your com-ments to:

Revision Editor James Publishing 3505 Cadillac Avenue, Suite H

Costa Mesa, CA 92626 First Edition, 1/92 Second Edition, 2/94 Third Edition, 12/99 Revision 1, 6/00 Revision 2, 11/00 Revision 3, 5/01 Revision 4, 11/01 Revision 5, 5/02 Revision 6, 12/03 Revision 7, 10/04 Revision 8, 10/05 Revision 9, 9/06 Revision 10, 11/07 Revision 11, 10/08 Revision 12, 10/09 Revision 13, 10/10 Revision 14, 11/11 Revision 15, 11/12

ABOUT THE AUTHORS

Phillip L. Jelsma is a partner in the San Diego law firm of Luce, Forward, Hamilton

& Scripps LLP where he specializes in tax law, with an emphasis on small business and international tax planning. Mr. Jelsma graduated from Stanford Law School in 1986 and from the University of Southern California in 1979. He worked for the Internal Revenue Service and Arthur Young & Company prior to joining Luce, Forward, Hamilton & Scripps LLP in 1987 and he is a certified public accountant in California. He also clerked for Judge Howard Turrentine of the Southern District of California.

Mr. Jelsma is the former Chair of the California State Bar Real Estate and Passthrough Committee and the former member of Executive Committee of the Taxation Section of the California Bar. Mr. Jelsma was a member of the Drafting Committee for California’s

Limited Liability Company Act (SB 469) and testified on the Act in both the Senate and the Assembly. He has also drafted portions of the subsequent LLC clean-up bills, SB 13, SB 141, SB 1234, AB 1828 and AB 1970 as well as the California Revised Uniform Partnership Act (“RUPA”). He has authored a portfolio book on the State Taxation of LLCs and LLPs for Tax Management.

Mr. Jelsma is the past Chair of the Partnerships and Limited Liability Companies Committee of the Business Law Section of the State Bar of California. He assisted in drafting the new Revised Uniform Limited Partnership Act (“Re-RULPA”), a proposal to allow owners to communicate electronically and proposed amendments to the welfare exemption for LLCs. He is currently a member of the National Conference of Commissioners on Uniform State Laws (“NCCUSL”) drafting committee on a new Uniform Limited Liability Company Act and Uniform Business Trust Act. He is member of the ABA’s Business Law Committee on Partnership and Unincorporated Business Organizations.

Mr. Jelsma has been an adjunct professor of law at University of San Diego since 1989 and has taught courses during the fall semester on Taxation of Real Estate Transactions and a summer course on LLCs and LLPs.

Pamela Everett Nollkamper is president of Gem Legal Management, Inc., a

con-sulting firm in Corona, California. She is on the faculty of Fullerton College in its legal studies program.

Her writing credits include author of LEGAL SECRETARY FEDERAL LITIGATION,

FOURTHEDITION(James Publishing, Inc.); BANKRUPTCYCOURTS& PROCEDURES(James

Publishing, Inc.) FUNDAMENTALS OFLAWOFFICEMANAGEMENT; SYSTEMS, PROCEDURES

AND ETHICS (West Publishing Co.); and many articles for several legal periodicals,

including LEGALASSISTANTTODAYmagazine.

Ms. Nollkamper holds a B.V.E. in vocational education and an M.A. in business

management. She is listed in WHO’SWHO INAMERICANLAW, WHO’SWHO OFEMERGING

LEADERS OF AMERICA, WHO’S WHO IN THEWEST, WHO’S WHO OFAMERICANWOMEN, WHO’S WHO IN FINANCE ANDINDUSTRY, WHO’S WHO IN AMERICANEDUCATION, THE

PAST AUTHORS

James L. Leet is a shareholder at McDonough Holland & Allen in Sacramento,

California. There he handles formation of limited liability companies and partnerships, corporate reorganizations, real estate exchanges, and business acquisitions. He is a fre-quent speaker and prolific writer on business and tax issues.

He received his J.D. from University of Santa Clara Law School and his LL.M. from

University of Florida. He is listed in BESTLAWYERS INAMERICA.

James Clarke, a shareholder at McDonough Holland & Allen in Sacramento,

California, provides corporate and tax counsel to a wide variety of private and publicly-traded companies. He has extensive experience in formation, operation, reorganization, and tax issues facing pass-through and corporate entities.

He received both his J.D. and his LL.M from McGeorge School of Law. He is listed in BESTLAWYERS INAMERICA.

Philip P. Whynott was one of the early champions of limited liability companies. He was a member of the

Wyoming Secretary of State’s Committee to rewrite the state’s corporation laws, and co-author of Wyoming

Corporate Law & Practice (Pioneer) and Legal Aspects of Doing Business in North America and Canada

Chapter 1

II

L

LL

LC

C

§1:10 Definition §1:20 History

§1:30 The LLC Comes to the United States

§1:60 Current Classification Regulations

§1:70 Current State Issues §1:80 Glossary

§1:90 Separate Entity Case Law Form 1-1 LLC Formation Checklist

Chapter 2

U

U

L

LL

LC

C

§2:10 Comparisons With Other Entities

§2:20 General Partnership Compared

§2:30 Limited Partnership Compared

§2:40 Registered Limited Liability Partnership Compared

§2:50 S Corporation Compared

§2:60 Regular Corporation Compared

§2:70 Corporation Tax Comparison: Employment Taxes

§2:75 Statutory Trusts Compared

§2:80 Different Uses for the LLC

§2:81 Operating an LLC as a Corporation

§2:82 LLC Election to Become a Corporation

§2:83 Sample Provisions for an LLC to Become an S Corporation for Tax Purposes

§2:90 Series Limited Liability Companies—General Description

§2:91 Series Limited Liability Companies—States Permitting Formation

§2:92 Series Limited Liability Companies—Uses

§2:93 Series Limited Liability Companies—Considerations

Form 2-1 Certificate of Formation (Delaware) Form 2-2 LLC Agreement for Series LLC Form 2-3 Contribution Agreement

Chapter 3

C

C

U

U

L

LL

LC

C

§3:10 Knowing the Client §3:20 Ethical Considerations

§3:30 Conflicts of Interest

§3:40 Former Clients

§3:50 Privilege and Confidentiality

§3:60 Management Misconduct

§3:70 Multiple Representation

§3:80 The Office “Early Warning System”

§3:90 Criminal Law Considerations §3:100 Securities Law Considerations

§3:110 Howey Approach

§3:130 Stock Characteristic Approach

§3:140 State Statutory Grounds Approach

§3:150 Partnership Guidelines for LLCs

§3:160 Federal and State Securities Laws

§3:170 Uniform Securities Act

§3:180 Registration of State Securities

§3:185 LLC Case Law—Securities

§3:190 Ownership Interest

§3:200 Concurrent Ownership

§3:210 Tenants-in-Common

§3:220 Joint Tenants With Rights of Survivorship

§3:230 Tenancy by the Entireties/Community Property

§3:240 Concurrent Ownership and 26 C.F.R. §1.301.7701 Classification Issues

§3:250 Concurrent Ownership Interests and LLC Voting Interests

§3:260 Concurrent Ownership and State Law Events of Dissolution

§3:270 Concurrent Ownership and Creditors

§3:275 Use of Trusts

§3:280 Conversion From Existing Entities

§3:285 Using LLCs in Corporate Mergers

§3:290 Preliminary Considerations §3:300 Conversion Procedures §3:305 LLC Case Law—Conversion §3:310 Forum Shopping §3:320 Miscellaneous Considerations

Chapter 4

F

F

L

LL

LC

C

§4:10 Role of the Advisor §4:20 Pre-Formation Issues

§4:21 Pre-Formation Case Law

§4:30 Factors to Consider Pre-Formation

§4:40 Organic Documents

§4:45 Signing of Articles of Organization

§4:50 Members

§4:51 Non-Member Contractual Rights

§4:55 Protecting the Minority Owner

§4:60 Ownership Forms

§4:70 Capital Structure and Contributions

§4:71 The LLC as an Exempt Organization

§4:72 LLCs as Joint Venture Vehicles Under IRS 501[c]

§4:73 Formation of the LLC as an Exempt Organization

§4:74 Low-Profit Limited Liability Companies

§4:80 Management

§4:90 Company Name

§4:100 Trade Name Protection

§4:110 Duration

§4:120 Out-of-State Operation

§4:130 Business Purpose

§4:140 Single-Purpose Entity

§4:150 Registered Agent and Office

§4:170 Effective Filing Date

§4:180 Professional LLCs

§4:190 Formation Choices—Non-Tax Considerations

§4:195 Formation Choices—Tax Considerations

§4:200 Pre-Formation Case Law

§4:210 Who Is the Client?

§4:220 Intent to Form

§4:230 Purpose

§4:240 Integration of Organic Documents

§4:250 Effect of Filing Articles

§4:260 Formation Requirements

§4:270 Professional LLCs

§4:280 Pre-Formation Liability

§4:290 Joint Ventures With Exempt Organizations

§4:300 Formation Choices—Tax Considerations

§4:310 Out-of-State Operations

Chapter 5

A

A

O

O

§5:10 Introduction §5:20 Statutory Mandates

§5:25 Terminology

§5:30 Drafting Issues

§5:40 Default Rules

§5:50 Compliance With State Statutes and Regulations

§5:60 Privacy Concerns, Identity Protection

§5:70 Purpose Clause

§5:80 Voting

§5:90 Opt-In Features

§5:95 Step-by-Step Article Drafting §5:100 Articles Checklist

§5:110 The Opt-In Checklist

§5:115 Signing the Articles of Organization

§5:120 Sample Clauses and Completed Articles

§5:130 Filing Articles of Organization §5:140 Amendments

§5:150 Mandatory Amendment

§5:160 Permissive Amendment

§5:170 Uniform Act

§5:180 Forms

§5:190 Formation Case Law

Chapter 6

L

LL

LC

C A

A

§6:10 Introduction §6:20 Drafting Issues

§6:30 Avoiding Abuse by Majority Owners

§6:50 Avoiding Potential Operational Deadlock

§6:60 Distribution of Profit and Allocations of Tax Gains and Losses

§6:70 Voting Rights and Percentages

§6:80 Divorce and Community Property

§6:81 Dissolution

§6:82 Assignment

§6:90 Arbitration and Mediation

§6:100 Default Rules

§6:105 Foreign or Out-of-State Operation

§6:110 Opt-In Features

§6:120 Opt-In Checklist

§6:130 Form and Content of the LLC Agreement

§6:135 Preparing the LLC Agreement/Management Provisions §6:140 Drafting Outline

§6:145 LLC Agreement as Contract §6:150 Maintenance of the LLC Agreement §6:160 Withdrawal of a Member

§6:170 Tax Provisions in LLC Agreements

§6:171 Tax Allocations Can Affect the Economic Consequences of the Members

§6:172 Distributions

§6:173 Self-Employment Taxes

§6:174 Capital and Profits Interest

§6:175 Special Allocations, Special Distributions, and Contributed Property Issues

§6:176 Elections Under IRC §754

§6:177 Tax Matters Member

§6:180 LLC Agreement Case Law §6:190 Forms on CD: LLC Agreements

Chapter 7

U

U

L

L

L

L

C

C

A

A

§7:10 Introduction

§7:20 LLC as Separate Entity

§7:30 Certificate of Organization

§7:40 “Opt-In” Feature

§7:50 Name

§7:60 Purpose and Powers

§7:70 Duration

§7:80 Term Company

§7:90 Management

§7:95 One-Member LLCs Permitted

§7:100 Designated Office and Agent

§7:110 Other Matters

§7:120 Filing

§7:130 Amendment of Certificate

§7:140 The Operating Agreement

§7:150 Default Rules: A Uniform Act Checklist

§7:160 Events of Dissociation

§7:170 Assignment of Ownership Interest

§7:180 Continuation

§7:190 Agency

§7:210 Limited Liability

§7:220 New Members

§7:230 Records

§7:240 Annual Report

§7:250 Merger, Conversion, and Domestication

§7:260 Distributions and Allocations

§7:270 Disclosure of Members

§7:280 Creditor's Rights

§7:290 Foreign LLCs

§7:295 Derivative Actions

§7:300 The Future of the Uniform Act

§7:310 Comments Regarding the Re-ULLCA

§7:400 Uniform Act Case Law

Chapter 8

O

O

§8:10 Introduction

§8:15 Step-by-Step Procedure for Organizational Meeting

§8:20 General Meetings

§8:25 Annual Check-Up

§8:30 Appointment of Committees

§8:40 Corporation as Manager

§8:50 Officers

§8:60 Meetings of Members or Management

§8:70 Notice Requirements

§8:80 Voting

§8:90 Voting Trust and Pooling Agreements

§8:100 Voting Trust Defined

§8:110 Pooling Agreements Defined

§8:120 Classification Issues in LLC Block Voting

§8:130 Examples of Block Voting Arrangements

§8:140 Specific LLC Operational Issues

§8:150 Liability

§8:160 Piercing the LLC Veil

§8:170 Rights and Remedies of Creditors of Members

§8:180 Management

§8:181 Majority or Supramajority Management Decisions

§8:182 Counting Votes

§8:190 Fiduciary Duty

§8:200 Agency

§8:210 Ownership Certificates

§8:215 Personal Residences or Vacation Home LLCs

§8:220 Reorganization, Dissolution and Reinstatement

§8:230 Withdrawal of Members

§8:240 Merger, Consolidations and Acquisitions

§8:250 Pre-Merger Notification

§8:251 State Merger Provisions

§8:260 Terminating the LLC

§8:270 Conversion From Existing Entities

§8:290 Conversion Procedures

§8:291 Conversion of General Partnership to LLC

§8:292 Conversion of Limited Partnership to LLC

§8:293 Conversion of General Partners of a Limited Partnership Into an LLC

§8:294 Conversion of Professional Partnership to LLC

§8:295 Conversion of an S Corporation Into an LLC

§8:300 Records

§8:310 Recommended Items

§8:320 Records

§8:330 LLC Documentation

§8:340 Members' Access to Records

§8:350 Annual Report

§8:360 Contributions of Capital, Distribution of Profits and Return of Capital

§8:370 Transfer of Ownership Interest

§8:371 Restrictions on the Transfer of Ownership Interests

§8:380 Pledge of Ownership Interest as Security for Debt

§8:390 Buy-Sell Agreements

§8:400 Types of Buy-Sell Agreements

§8:410 Enforceability of Buy-Sell Agreements

§8:420 Funding of Buy-Sell Agreements

§8:430 Valuation of Buy-Sell Agreements

§8:440 Drafting the Buy-Sell Agreement

§8:445 Foreign LLCs

§8:450 Business Operations Outside the Home State

§8:460 Effect of Failure to Obtain Certificate of Authority

§8:470 Liability Issues in Non-Home State Operations

§8:480 The Single-Member LLC

§8:490 Single-Member Taxation

§8:500 Disregarded Single-Member LLC

§8:510 Single-Member LLC Issues

§8:520 Single-Member Operating Agreement

§8:530 Single-Member Liability Protection

§8:600 Buying and Selling LLCs

§8:610 Methods of Purchase

§8:620 Steps in LLC Purchase Process

§8:630 Operations Case Law

§8:631 LLC Operations §8:632 Single Members §8:633 Managers §8:634 Management §8:635 Agency §8:636 Personal Liability §8:637 Distributions §8:638 Successor in Interest/Conversion §8:639 Creditor’s Remedies §8:640 Withdrawal/Dissolution §8:641 Foreign LLCs §8:642 Fiduciary Duties §8:643 Transfer of Interests

Chapter 9

A

A

P

P

E

E

P

P

§9:00 Introduction §9:10 Asset Protection

§9:15 Asset Protection Strategy

§9:20 Traditional Approaches to Asset Protection

§9:21 Offshore Uses

§9:30 Case Studies

§9:40 Case Study 1 (Overthrust Joint Ventures)

§9:50 Case Study 2 (Paradise Valley Ranch)

§9:60 Case Study 3 (Smedley and Smedley-Lopez Law Office)

§9:70 Case Study 4 (Good Times Auto Dealer)

§9:80 Estate and Family Succession Planning

§9:90 Discussion

§9:100 State LLC Acts

§9:110 The Alaska Approach

§9:120 The Uniform Act Approach

§9:130 The Wyoming Approach

§9:131 Modified Wyoming Close Approach

§9:140 The New Mexico Approach

§9:141 The Nevada Approach

§9:142 Obama Administration Response

§9:150 Estate Valuation Discounts

§9:160 Drafting Solutions

§9:170 The Alaska Approach

§9:180 The Uniform Approach

§9:190 The Wyoming Approach

§9:191 Modified Wyoming Close Approach

§9:200 Other Uses of Assignees in Estate Planning

§9:210 LLC Control and Estate Planning

§9:220 Ancillary Probate and LLCs

§9:230 Family LLCs and Income-Splitting

§9:240 Annual Gifting

§9:300 Asset Protection/Fraudulent Conveyance

§9:310 Asset Protection Articles

§9:320 LLC Estate Planning Case Law

Chapter 10

II

§10:10 The International LLC

§10:20 Classification of International LLCs

§10:30 Taxation of an International LLC

§10:40 The International Hybrid LLC

§10:50 International LLC Tax Considerations

§10:60 Transfers to International LLCs

§10:70 Federal Tax Treatment

§10:80 10-50 Corporations

§10:90 Foreign Tax Credits

§10:100 Tax-Free, Foreign-Owned U.S. LLCs

§10:120 U.S. Income Tax Withholding

§10:130 Withholding Requirements

§10:140 Non-Effectively Connected Income

§10:150 Effectively Connected Income

§10:170 Immigration and LLCs

§10:180 Treaty Trader/Investor LLC

§10:190 International LLC Forms

Chapter 11

L

L

§11:10 Introduction

§11:20 Step-by-Step Access to LLC Records

§11:30 Validity of LLC’s Existence

§11:40 Single-Member LLCs

§11:45 Articles’ Purpose Clause

§11:50 Mandatory Amendment to Articles of Organization

§11:60 Failure to Follow Documents

§11:70 Threshold Issues

§11:80 Formation

§11:90 Continuing Validity

§11:100 Member Definition

§11:110 Jurisdiction for Federal Diversity

§11:115 Service of Process

§11:120 Theories of Recovery

§11:125 Appropriate Court

§11:130 Piercing the LLC Veil

§11:140 State Approaches/Cases §11:150 Creditor’s Rights §11:160 Involuntary Bankruptcy §11:170 LLC as Bankruptcy Debtor §11:180 Treatment §11:190 Dissolution Litigation §11:200 Liquidation Procedures §11:210 Loss of Liability §11:220 Continuation §11:230 Recovery Theories §11:240 Derivative LLC Suits

§11:250 Establishing an Event of Dissolution

§11:255 Dissociation

§11:260 Defenses

§11:270 Capitalization Issues

§11:280 Characterization of Member Contributions

§11:300 Recovery

§11:310 Defenses

§11:320 Amount of Recovery

Chapter 12

T

T

§12:10 Federal Tax Considerations

§12:20 Classification

§12:30 Check-the-Box Regulations

§12:40 Elective Classification System

§12:50 Late Classification Filing

§12:60 Key Definitions

§12:70 Classification Process

§12:80 Taxpayer I.D. Numbers in Multi-Member LLCs

§12:90 Election Classification Process

§12:100 Single-Member Taxation

§12:110 Introduction

§12:120 Single-Member LLC Taxpayer Identification Numbers

§12:121 Single-Member LLC May Affect Basis in Another LLC

§12:130 Conversion to Single-Member LLC

§12:140 Conversion From Single-Member LLC to Multi-Member

§12:150 Single-Member LLCs and Marital Property/Tenancy by the Entireties

and Community Property

§12:170 LLC Partnership Taxation

§12:180 In General

§12:190 Taxation of Member Contributions

§12:200 Tax Allocations with Respect to Contributed Property

§12:201 Allocation of Deductions Attributable to Contributed Property

§12:202 Allocation of Deductions of Appreciated Property and Other

Consequences After Admitting a New Member

§12:203 Allocation of Income and Deductions

§12:210 Pass-Through Taxation

§12:220 Basis and Distribution

§12:230 Effect of Debt on Member's Basis

§12:240 Allocation of Partnership Tax Items

§12:250 Termination

§12:260 Member Withdrawal and Retirement

§12:270 Section 734 and Section 743 Basis Adjustment

§12:280 Application of At-Risk Rules

§12:290 Members Affected

§12:300 Suspended Losses

§12:310 Real Estate Exception

§12:320 Passive Loss Restrictions

§12:330 [Reserved]

§12:340 General Rule

§12:350 Material Participation

§12:360 General Rule

§12:370 Application to Limited Partners

§12:380 Application to Members and Managers

§12:400 Formation and Operation Issues

§12:410 Contribution of Appreciated Property

§12:420 Classes of Ownership

§12:430 Securities

§12:440 Distributions

§12:450 Allocations

§12:460 Deductions of LLC Losses by Members

§12:470 Limitations on Deductions

§12:480 Merger, Consolidation and Conversion Issues

§12:490 Overview

§12:500 Partnership Conversion

§12:501 Partnership/LLC Merger

§12:502 Division of an LLC

§12:510 Conversion of Limited Partnership to LLC

§12:520 Professional Partnership Conversion

§12:530 Corporation Conversion

§12:540 Dissolution Issues

§12:550 Continuation or Winding Up

§12:560 Application to Managers

§12:570 Tax Matters Partner

§12:580 Designation

§12:590 Power to Represent LLC

§12:600 Accounting Methods; Taxable Year

§12:610 Overview

§12:620 Self-Employment Tax Issues

§12:630 Single-Member Employment Taxes

§12:640 Multiple-Member LLCs Employment Taxes

§12:650 Estate and Gift Tax Valuation Discounts

§12:660 Family LLCs and Income-Splitting

§12:670 Overview

§12:680 Discount Valuation Restrictions Caused by IRC §2704(b)

§12:690 Avoiding Discount Valuation Problems

§12:700 Drafting Solutions

§12:710 Employer Trust Funds

§12:720 Overview

§12:730 Definition of “Responsible Person”

§12:740 Steps to Minimize Liability

§12:750 Single-Member LLCs and Responsible Person

§12:760 Levying on Assets of LLC/Collection Activity

§12:770 The LLC as an Exempt Organization

§12:780 Use of the LLC as an Exempt Organization

§12:790 Anti-Abuse Regulations

§12:800 Overview

§12:810 State Tax Considerations

§12:820 Overview

L

LL

LC

C F

F

C

C

2

20

01

12

2

S

S

&

& T

T

S

S

C

C

Alabama Alaska Arizona Arkansas California Colorado Connecticut Delaware District of Columbia Florida Georgia Guam Hawaii Idaho Illinois Indiana Iowa Kansas Kentucky Louisiana Maine Maryland Massachusetts Michigan Minnesota Mississippi Missouri Montana Nebraska Nevada New Hampshire New Jersey New Mexico New York North Carolina North Dakota Ohio Oklahoma Oregon Pennsylvania Rhode Island South Carolina South Dakota Tennessee Texas Utah Vermont

Virgin Islands (United States) Virginia Washington West Virginia Wisconsin Wyoming

II