1. Limited liability

2. Continuity of life

3. Centralization of management

4. Free transferability of interests

Based on a strict interpretation of Reg. Sec. 301.7701-2(a)(1), regardless of what the entity is called, it will be treated as a corporation if it has more than two of the above-referenced characteristics. LLCs would typically constitute partnerships as they would normally only have two of the characteristics: centralized management and limited liability.

As of November 1994, 46 states and the District of Columbia had LLC statutes on their books. There are only three states in which LLC statutes remain to be enacted: Hawaii, Massachusetts, and Vermont. Puerto Rico also has not enacted an LLC statute. Pennsylvania's LLC bill is pending approval by the state senate and the governor. The measure would be effective 60 days after enactment. Maine's LLC statute is not effective until 1995.

It is important to note that there is no "standard" LLC. State statutes vary, and a particular LLC may be taxed as a partnership while another LLC may be taxed as a corporation. The key, however, to obtaining partnership treatment is to ensure that an LLC does not have more corporate characteristics than partnership characteristics.

In a case where a conversion to an LLC or the formation of a new LLC is being contemplated, a check of the applicable state laws is required to determine what procedures are necessary through which a foreign LLC may apply for authority to do business within that particular state.

A domestic or foreign LLC is normally classified as an entity for state income tax purposes in the same manner as it is for Federal income tax purposes in that state.

General Characteristics

States with "bullet proof" statutes (e.g., Delaware, Colorado, and Virginia) mandate certain provisions and are more rigid in the permissible wording of LLC operating agreements; however, these states also provide more security that Federal partnership taxation status will be attained. Other states with more flexible statutes (e.g., New York and New Jersey) allow for more flexibility in drafting LLC operating agreements. They require, however, closer scrutiny in drafting the LLC operating agreement to ensure that Federal partnership taxation status is not jeopardized.

In the case of an LLC that qualifies as a partnership for Federal income tax purposes, LLC members can contribute property without gain recognition and enjoy other favorable partnership tax attributes.

Members may include corporations, partnerships, exempt organizations, pension plans, and nonresident aliens. LLCs can have more than one class of equity capital.

Certain states permit the use of LLCs by professionals. The liability protection afforded to members will be similar to a professional corporation - all professionals are fully and personally liable for their own negligence but are relieved from vicarious liability.

The following paragraphs highlight some of the major advantages and disadvantages of an LLC.

Advantages

An LLC provides corporate liability protection in an unincorporated form. LLCs are not subject to Federal income tax at the corporate level. A loan to an LLC increases the basis of the LLC member. LLCs are not subject to corporate governance issues and allow for more operational flexibility. An LLC provides more flexibility as to the number and type of owners, unlike the limitations placed on S corporations.

All members can be active in business without restriction or penalty, unlike a limited partnership.

Disadvantages

A major drawback is the uncertainty surrounding LLCs because they are a new type of entity. There is no tested case law, regulations, etc.

Converting from a partnership to an LLC is not a taxable event as both are unincorporated entities; however, converting from a corporation results in a taxable liquidation of the corporation.

The various differences among the state statutes create confusion and difficulty, especially if interstate commerce is involved. There is a need for more uniformity in LLC laws.

The restrictions regarding continuity of life and transferability of interests can create some operating difficulties in trying to satisfy business needs while keeping the partnership tax status. Start-up costs including cost of public notices can be high. Estate tax consequences for nonresident aliens are also complicating factors.

The Uniform Law Commissioners at their National Conference of Commissioners on Uniform State laws in August 1994 passed a Uniform Liability Act to assimilate the best qualities of state legislation, modern law practice, and most recent developments in tax rulings in an effort to provide a measure of uniformity. The Act sets out matters to be included in the articles of organization:

* Specifics and limits of member and manager liabilities;

* Allocation of profits, losses and distributions;

* Methods of merger or dissolution of LLCs and conversion to LLCs from other entity types;

* Conduct of business in states as foreign LLCs;

* Definitions of the two types of LLCs (i.e., manager-managed and member-managed); and

* The fact that debts, obligations, and liabilities are solely those of the company.

Among the advantages outlined above, an LLC can offer protection from vicarious liability and eliminate limitations long associated with other types of entities. Today's business decision maker in considering the appropriate choice through which to operate his or her enterprise can now consider the LLC in addition to the alternatives of an S corporation, general and limited partnerships, and business trusts.