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ProGuide™ - Legal Forms is pleased to make these continuing legal education materials available to you. However, please note that while still quite useful, portions of the materials discuss issues which have been clarified by the "check_a_box" and other regulations subsequently adopted by the Internal Revenue Service. Thus, the materials, as set forth, should not be relied upon as reflecting the current state of the law and great care should be used to ensure that all legal references and all conclusions reached are still correct and have not been rendered obsolete by statutes, regulations, rulings and other pronouncements of the Internal Revenue Service, the courts, and various state agencies.

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I.   Introduction

               A.   Review of Characteristics Affecting Tax Classification

                    1.   Limited Liability - Always Present

                    2.   So, for "partnership" classification, can only

                         have one more of the following characteristics:

                         a.   Free Transferability of Interests - heavily

                              facts & circumstances

                              (1)  all but 20% can be freely transferable

                              (2)  may exist if a small group actually

                                   controls the entity

                                   (a)  IRS suggests that documents can

                                        provide for restricted transfer

                                        rights &/or dissolution on

                                        attempted transfer and avoid free

                                        transferability even if the entity

                                        is controlled by a small group

                         b.   Centralized Management

                              (1)  Requires that management be concentrated

                                   in a small group

                                   (a)  IRS current view is if entity is

                                        manager managed, it has centralized


                                   (b)  possible to have a smaller group

                                        actually carry out management

                                        activities so long as all members

                                        have actual management authority

                         c.   Continuity of Life

                              (1)  can be avoided even if only a small

                                   group of events will be an act of

                                   dissociation and less than all members

                                   can approve continuation

          II.  General Considerations. 

               A.   An LLC should be considered for most types of business


                    1.   Some types of business activities cannot be

                         conducted by LLCs such as insurance and banking

                         and some professions

                         a.   If business will operate multi-state, must

                              check all states.

                    2.   LLC can offer many of the desirable features of

                         corporations with the operating flexibility and

                         tax benefits of partnerships.

                    3.   Prime candidates are:

                         a.   Any business which currently uses a

                              partnership form of business

                         b.   Businesses which use a limited partnership

                              with either a C or S corporation as a general


                         c.   Informal ownership arrangements (eg. tenants

                              in common)

                    4.   Caveat - business operating in states which have

                         not adopted an LLC statute should be viewed


                         a.   If limited liability is not important, this

                              may still be satisfactory

                              (1)  eg. primary risk is easily insured

                         b.   uncertainty re licensing (who gets license),

                              ability to sue, etc. - may make use


          III. Characteristics of the LLC Affecting How It Is Used

               A.   Limited Liability

                    1.   All members shielded from personal liability

                         a.   like corporation

                         b.   uncertainty in some states

               B.   Flexible Management

                    1.   All members can actively participate - member


                         a.   no loss of limited liability as in the case

                              of a limited partnership

                    2.   Management can be restricted:

                         a.   "manager managed"

                              (1)  can be by members or non-members

                         b.   member managed, but leave authority to manage

                              in all members but have smaller group of

                              members actually administer it

                         c.   Those without expertise need not be involved

                              in management

               C.   Flexible Ownership

                    1.   Generally there are no restrictions

                         a.   Different than S corporation's restrictions

                              on ownership

                              (1)  eliminates constant monitoring and/or

                                   complex agreements restricting ownership

                         b.   No legal restriction on number of owners

                              (1)  May get unwieldy if too large

                              (2)  May have more complex securities rules

                                   and fall into special tax rules re large

                                   and/or publicly traded partnerships

                         c.   Generally, no legal restriction on nature of


                              (1)  foreigners (resident or non-resident),

                                   corporations, partnerships, trusts,

                                   charitable institutions, pension plans,

                                   estates, and other LLCs may all be


                              (2)  An S corporation can use an LLC

                                   (a)  may give it some of the same

                                        advantages that C corporations can

                                        get from owning a subsidiary

                                   (b)  can insulate some assets from the

                                        remaining assets

                                   (c)  Since need two members, must be

                                        another person or entity involved

                                        i)   S corporation should be able

                                             to own almost 99%

                                        ii)  Could structure arrangement to

                                             allow S corporation's

                                             shareholder(s) to own

                                             remaining interests.

                         d.   Sometimes, licensing requirements of a

                              particular business or profession will

                              require limitations on ownership which are

                              not required by LLC law or tax rules

               D.   Ownership Easily Controllable

                    1.   Statute restricts ability to transfer ownership

                         and/or management rights

                         a.   Can not become a member without the approval

                              of at least some others

                              (1)  Fewer negotiations may be needed as the

                                   statutory default may be ok

                         b.   May be able to pre-approve transfer of some

                              interests and still avoid IRC "free

                              transferability" characteristic.

               E.   Flexible Organization Structure

                    1.    May be simple

                         a.   All ownership interests can be identical

                         b.   No need for general and limited partners

                    2.   May be complex

                         a.   Can differ the economic and voting rights of

                              members and create numerous classes of

                              ownership rights

                              (1)  flexibility in allocation of rights:

                                   (a)  on liquidation

                                   (b)  profits & losses

                                   (c)  cash flow

                                   (d)  priorities in dissolution

                              (2)  Watch IRC 704(b) allocation Regs.

               F.   Flexibility In Types of Capital Contributions

                    1.   Capital contributions can be in cash, property,

                         services, promissory notes or other obligations to

                         contribute cash or property or to render services

                         in the future

               G.   Readily Transferable Economic Interests

                    1.   Statute allows assignment of rights to profits,

                         losses, and all distributions without any


                    2.   Free transferability of interests will still not


               H.   LLCs Can Have "Subsidiaries"

                    1.   LLC may own other entities, including:

                         a.   corporation,

                         b.   general partnership

                         c.   limited partnership

                         d.   another LLC

                    2.   Allows protection of limited group of  assets

                         a.   Use corporation or another LLC

                    3.   May allow "consolidation" of profits and losses

                         for tax purposes

                         a.   Use another "pass through" entity

                    4.   May allow preservation of limited liability in

                         states without a limited liability statute

                         a.   use corporation

               I.   Familiar to Foreign Investors

                    1.   Similar to a GmbH and other entities used

                         through out Europe and South America

               J.   Uncertainty As to How Treated Under Substantive State &

                    Federal Law

                    1.   Questions exist regarding:

                         a.   Will the limited liability provisions

                              contained in the state of organization's LLC

                              statute be accepted in the other states in

                              which the LLC operates?

                         b.   Can an LLC sue or be sued in its own right in

                              such other states?

                         c.   Since there is little law regarding LLCs, how

                              will the organizational state and other

                              states apply case law or legal precedent in

                              other areas to LLCs, since there is little

                              authority actually pertaining to LLCs

                         d.   How will state securities laws apply to the

                              transfer of an LLC?

                              (1)  Transfer of interest as member?

                              (2)  Transfer of interest in economic rights


               K.   Uncertain State Tax Treatment

                    1.   Some uncertainty as to how the organizational

                         state will handle some tax issues.

                    2.   Great uncertainty as to how states without LLC

                         statutes will handle taxation issues.

                    3.   Some issues are:

                         a.   How will the entity be treated for multi-

                              state tax allocation purposes?

                         b.   Will a sale of an interest be treated as

                              intangible personal property, similar to the

                              sale of stock, so that gain is taxed to the

                              members state of residency?

                              (1)  Most LLC statutes classify an LLC

                                   interest as personal property so expect

                                   similar treatment to that of stock

                              (2)  Liquidation of the LLC and distribution

                                   of assets to the members can avoid LLC

                                   level taxation and can change the source

                                   of the intangible assets

                                   (a)  How will LLCs be treated?

                                   (b)  Will it be effected by whether

                                        state taxes LLC as a corporation?

                              (3)  Many other issues.

          IV.  Some Tax Considerations Affecting Use

               A.   General

                    1.   To claim a deduction for a loss generated by a

                         pass-through entity on his or her individual

                         income tax return, taxpayers must have the loss

                         allocated to them by either operation of law or by

                         agreement.  However, in addition, certain types of

                         taxpayers (it varies with the statute)must meet

                         additional requirements.  More specifically:

                         a.   his or her basis in the investment must be

                              sufficient to allow the use of the deduction,

                         b.   he or she must be at risk with regard to the

                              amount of the loss

                         c.   and if the loss is a passive activity loss,

                              it may only be used to offset income from

                              passive activities.

               B.   Allocation of Profits and Losses - IRC 704

                    1.   Generally, the Wisconsin LLC statute provides that

                         profits and losses will be divided between members

                         in proportion to the respective values of their

                         interests as required to be maintained in the

                         records of the LLC.  It also allows the members to

                         vary that arrangement in any way they wish in an

                         operating agreement,

                    2.   However, sections 704(a) and (b) of the IRC sets

                         forth very lengthy and complex rules regarding the

                         allocation of profits and losses between partners.

                         These rules allow IRS to disregard the agreed upon

                         allocation if they do not have a "substantial

                         economic effect" - that is, an economic loss

                         consistent with the allocated loss. (Essentially,

                         a safe harbor exists if certain criteria are met

                         and either a deficit restoration agreement exists

                         or qualified income offset will be made. A

                         discussion of these rules is beyond the scope of

                         these materials.)

                    3.   Since the basic set of "substantial economic

                         effect" rules contained in the regulations do not

                         apply to non-recourse debt, it is necessary to

                         distinguish between categories of debt.  In this

                         instance, several different categories of debt,

                         other than recourse debt, are considered by the

                         regulations.  All of them have a bearing on LLCs

                         and their members.

                         a.   Essentially, debt is divided into non-

                              recourse and recourse liabilities, as tested

                              by reference to the members and certain

                              related persons - not the LLC.

                              (1)  Non-recourse liabilities are then

                                   subdivided into:

                                   (a)  secured non-recourse liabilities


                                   (b)  exculpatory liabilities

                              (2)  Recourse liabilities are divided into

                                   (a)  partnership non-recourse

                                        liabilities and

                                   (b)  other recourse liabilities

                    4.   Because of the limited liability attribute of the

                         LLC, it will generally be considered as having

                         non-recourse debt. If, however, a member

                         guarantees the LLC's debt or the LLC borrows the

                         funds from a member or a person related to the

                         member, the debt will be treated as partner non-

                         recourse debt.  See Treas.  Reg.  1.752-2.

                         a.   Non-recourse liabilities are treated as not

                              having actual economic effect since only the

                              creditor bears any economic risk.  Thus, the

                              regulations artificially allocate non-

                              recourse debts to the members as if they had

                              economic effect if certain requirements are

                              met, including the minimum chargeback

                              requirement which allocates to those

                              receiving the deductions, gains from the sale

                              of the asset or the repayment of the debt,


                         b.   If there is partner nonrecourse debt, the

                              rules allocate the deductions attributable to

                              the liability to the person who bears the

                              economic risk of loss.  Rules similar to the

                              minimum chargeback rules also apply.

                    5.   Although the rules are detailed and complex, the

                         important thing to remember is that the

                         allocations of losses and gains, etc., will be

                         influenced by the categorization of the debt and

                         compliance with the allocable rules.  Because most

                         debt of an LLC will likely be non-recourse debt,

                         the negotiation of the terms of a bank loan will

                         take on greater significance to members than they

                         might to partners, etc.

               C.   At Risk Rules - IRC 465

                    1.   In general,  a person is "at risk" for the amount

                         of money they contributed to the entity, the

                         adjusted basis of any property they contributed to

                         the entity, and the amount of any debt of the

                         entity for which they are personally liable. (IRC

                         465(a) and (b)).  This amount is also increased by

                         any income allocable to the person plus any

                         additional contributions made by him or her.  It

                         is reduced, however, by the amount of any losses

                         taken and distributions received.

                    2.   Under normal conditions, the owner of an LLC will

                         not be liable for the debt of the LLC because of

                         the limited liability attribute of LLCs.

                    3.   While it is not completely certain, a loan by a

                         partner to a partnership should be treated as at

                         risk to the extent of their allocable share of the

                         debt.  Prop. Reg. 1.465-7

                         a.   It is not clear, however, what the rule is in

                              the case of a limited partnership or LLC,

                              where the members or limited partners have no

                              direct liability for the debt and the member

                              making the loan may bear all of the actual


                         b.   Similarly, it is not clear what the result is

                              if the member of the LLC guarantees the debt

                              of the LLC.

                              (1)  Logic would say that the member is at

                                   risk, however, subchapter S shareholders

                                   are not treated as at risk when they

                                   guarantee the corporation's loan. See

                                   Prop. Reg. 1.465-24.

                         c.   This issue is important since in many small

                              business operations, the bank will require a

                              personal guarantee of the loan.  It might be

                              wise to make the loan to the members rather

                              than the entity if the member will not be at

                              risk for the guaranteed amount.

                    4.   Another issue arises in connection with the

                         financing of real estate and pertains what is

                         referred to in the at risk rules as qualified non-

                         recourse financing."

                         a.   Under this rule, if an entity incurs debt in

                              connection with a real estate activity and

                              the financing is qualified non-recourse

                              financing, then the owners may be treated as

                              being at risk for a share of the debt even

                              though none of the owners are actually

                              liable.  In general, qualified non-recourse

                              financing is financing borrowed from a bank

                              or other similar qualified lender for which

                              no one is personally liable and which is

                              secured by the real estate.

                         b.   The issue that arises in connection with LLCs

                              is the question of whether the LLC is a

                              "person" which may be liable on the debt or

                              whether it should be disregarded.

                              (1)  Susan Hamill, a member of the staff of

                                   the IRS Office of the Chief Counsel,

                                   while expressing her own personal views,

                                   indicated that if the loan were only

                                   secured by the real estate being

                                   financed, the members of the LLC would

                                   likely be treated as at risk with

                                   respect to the debt.  However, she

                                   expressed uncertainty as to the result

                                   if the LLC secured the loan with all of

                                   its assets.

               D.   Passive Activity Rules - IRC 469

                    1.   There are at least four "issues" involving the

                         "passive loss" provisions of the IRC which are

                         unique to LLCs.  All four turn on the meaning of

                         the term "limited partner" or "general partner"

                         within the context of the various sections of IRC

                         469.  Three of them pertain to rental real estate

                         activities and are discussed, below, in that


                    2.   The first issue is, "What level of participation

                         must an LLC member have in order to be treated as

                         "materially participating" under IRC 469(h)(2)."

                              (1)  Generally, IRC 469 provides that for

                                   certain specified persons and entities,

                                   passive activity losses and credits will

                                   not be allowed. IRC 469(a)(1).

                              (2)  IRC 469 (c)(1) requires that the conduct

                                   of a trade or business will be passive

                                   if the taxpayer does not "materially

                                   participate" in it .

                              (3)  IRC 469(h) defines material

                                   participation. It provides that "A

                                   taxpayer shall be treated as materially

                                   participating in an activity only if the

                                   taxpayer is involved in the operations

                                   of the activity on a basis which is--

                                   (A) regular, (B) continuous, and (C)


                              (4)  Treas. Reg. 1.469-5T expands upon this

                                   general rule and provides that, with two

                                   exceptions which are found in paragraphs

                                   (e) and (h)(2) of the regulation, one of

                                   seven (7) conditions must be met in

                                   order for an individual to be treated as

                                   materially participating.  Those 7 tests


                                   "(1) The individual participates in the

                                   activity for more than 500 hours during

                                   such year;

                                   (2) The individual's participation in

                                   the activity for the taxable year

                                   constitutes substantially all of the

                                   participation in such activity of all

                                   individuals (including individuals who

                                   are not owners of interests in the

                                   activity) for such year;

                                   (3) The individual participates in the

                                   activity for more than 100 hours during

                                   the taxable year, and such individual's

                                   participation in the activity for the

                                   taxable year is not less than the

                                   participation in the activity of any

                                   other individual (including individuals

                                   who are not owners of interests in the

                                   activity) for such year;

                                   (4) The activity is a significant

                                   participation activity (within the

                                   meaning of paragraph (c) of this

                                   section) for the taxable year, and the

                                   individual's aggregate participation in

                                   all significant participation activities

                                   during such year exceeds 500 hours;

                                   (5) The individual materially

                                   participated in the activity (determined

                                   without regard to this paragraph (a)(5))

                                   for any five taxable years (whether or

                                   not consecutive) during the ten taxable

                                   years that immediately precede the

                                   taxable year;

                                   (6) The activity is a personal service

                                   activity (within the meaning of

                                   paragraph (d) of this section), and the

                                   individual materially participated in

                                   the activity for any three taxable years

                                   (whether or not consecutive) preceding

                                   the taxable year; or

                                   (7) Based on all of the facts and

                                   circumstances (taking into account the

                                   rules in paragraph (b) of this section),

                                   the individual participates in the

                                   activity on a regular, continuous, and

                                   substantial basis during such year.

                              (5)  Thus, it would appear that whether a

                                   general or limited partner for tax

                                   purposes, meeting any of the above 7

                                   tests would cause a taxpayer to meet

                                   the "material " participation"


                              (6)  However, IRC section 469(h)(2) also

                                   provides that:

                                        Except as provided in regulations,

                                        no interest in a limited

                                        partnership as a limited partner

                                        shall be treated as an interest

                                        with respect to which a taxpayer

                                        materially participates (Emphasis


                                   The term limited partner is not defined

                                   in the IRC and other sources must be

                                   looked to for assistance.

                              (7)  Treas. Reg. 1.469-5T(e) provides that,

                                   except as provided in paragraph

                                   (e)(3)(ii) of 1.469-5T, for purposes of

                                   section 469(h)(2) and paragraph (e) of
                                   that regulation, a partnership interest

                                   will be treated as a "limited

                                   partnership" interest if either:

                                   (a)  the interest is designated a

                                        limited partnership interest in the

                                        limited partnership agreement or

                                        the certificate of limited

                                        partnership (whether or not there

                                        is actual limited liability under

                                        state law), or

                                   (b)  there is actual limited liability

                                        under state law.

                              (8)  Under this definition of a limited

                                   partnership interest, all interests of

                                   members of an LLC would appear to be

                                   "limited partnership interests" for

                                   purposes of section 469(h)(2) and (e) of

                                   Treas. Reg. 1.469-5T and a member would

                                   not be treated as "materially

                                   participating", even if one of the 7

                                   tests described above were met. IRC

                                   469(h)(2) and Treas. Reg. 1.469-


                              (9)  Treas. Reg. 1.469-5T(e)(2) provides some

                                   minimal relief, however, to holders of a

                                   "limited partnership interest" by

                                   providing that the holder will still be

                                   treated as materially participating if

                                   they meet tests (1), (5) or(6) set forth

                                   above. Those tests are:

                                        (1) The individual participates in

                                        the activity for more than 500

                                        hours during such year;

                                        (5) The individual materially

                                        participated in the activity

                                        (determined without regard to this

                                        paragraph (a)(5)) for any five

                                        taxable years (whether or not

                                        consecutive) during the ten taxable

                                        years that immediately precede the

                                        taxable year;

                                        (6) The activity is a personal

                                        service activity (within the

                                        meaning of paragraph (d) of this

                                        section), and the individual

                                        materially participated in the

                                        activity for any three taxable

                                        years (whether or not consecutive)

                                        preceding the taxable year;

                                   These tests are very restrictive; much

                                   more so than those provided in the

                                   remainder of the 7 tests, and

                                   substantially restricts the use of

                                   losses. etc. by holders of "limited

                                   partnership interests."  Fortunately,

                                   other relief is, perhaps, available.

                              (10) Treas. Reg. 1.469-5T(3)(ii) provides


                                   A partnership interest of an individual

                                   shall not be treated as a limited

                                   partnership interest for the

                                   individual's taxable year if the

                                   individual is a general partner in the

                                   partnership at all times during the

                                   partnership's taxable year ending with

                                   or within         the individual's

                                   taxable year (or the portion of the

                                   partnership's taxable year during which

                                   the individual (directly or indirectly)

                                   owns such limited partnership interest).

                              (11) No definition of "general partner",

                                   however, appears in either the IRC or

                                   the regulations.

                              (12) Rev. Pro. 89-12, dealing with the

                                   classification of an entity, provides in

                                   section 1.02 that:

                                        Any reference to a "limited

                                        partnership" includes an

                                        organization formed as a limited

                                        partnership under applicable state

                                        law  and any other organization

                                        formed under a law that limits the

                                        liability of any member for the

                                        organization's debts and other

                                        obligations to a determinable fixed

                                        amount. References to "general

                                        partners" and "limited partners"

                                        [apply] also to comparable members

                                        of an organization not designated

                                        as a partnership under controlling

                                        law and documents; the  "general

                                        partners" of such an organization

                                        will ordinarily be those with

                                        significant management authority

                                        relative to the other members.

                                        (Emphasis and underlining added.)

                              (13) This definition, or the lack of a real

                                   definition, leaves a great deal of
                                   uncertainty regarding which of the

                                   requirements of the 7 tests must be met

                                   by a member of an LLC.  However, some

                                   additional analysis may be useful.

                                   Consider the following:

                                   (a)  The IRC 469(h) requirement that

                                        persons holding limited partnership

                                        interests be treated as not

                                        materially participating in an

                                        activity, and the more restrictive

                                        position taken by the IRS in the

                                        regulations, are both consistent

                                        with the general state law

                                        requirements which prevent a

                                        limited partner from actively

                                        participating in the management of

                                        the limited partnership.

                                   (b)  IRC 469(h) and its legislative

                                        history specifically contemplate

                                        that IRS will promulgate

                                        regulations which handle these

                                        situations.  However, no such

                                        regulations have been drafted.

                                   (c)  IRC 469(h), by its language, also

                                        addresses only limited

                                        partnerships.  The legislative

                                        history suggests that it is the

                                        management characteristic, not the

                                        limited liability characteristic,

                                        which is pertinent to the issue of

                                        "material participation".

                                   (d)  Treas. Reg. 1.469-5T(e)(2), Treas.

                                        Reg. 1.469-5T(3)(ii) and Rev. Proc.

                                        89-12 all look to the level of

                                        management activity which is

                                        attached to the interest in

                                        determining the difference between

                                        a general partnership interest and

                                        a limited partnership interest.

                                        Even where the interest is a

                                        "limited partnership interest",

                                        material participation is found and

                                        the passive loss allowed when the

                                        amount of activity is significant.

                                   (e)  Perhaps more importantly,

                                        shareholders in Subchapter S

                                        corporations need only meet any of

                                        the seven tests to qualify for the

                                        use of the passive loss and there

                                        seems no reason to distinguish

                                        between a Sub. S corporation and an


                                   (f)  Members in a member managed LLC

                                        would seem more like general

                                        partners than do Subchapter S


                                   (g)  LLC members in a manager managed

                                        LLC should be more cautious since

                                        they have restricted management

                                        authority (but not necessarily

                                        compared with other members, if

                                        none are managers) and come more

                                        readily within the concepts of

                                        Rev.Proc. 89-12.

                                   (h)  Notwithstanding the fact that there

                                        may be no logical reason for

                                        distinguishing between Sub. S

                                        corporation shareholders and LLC

                                        members, LLC members in a manager

                                        managed LLC whose managers are

                                        members but consist of less than

                                        all of the members, fall almost

                                        squarely within the description of

                                        the relationships contained in Rev.

                                        Proc. 89-12 and are most readily

                                        separated into categories of

                                        general and limited partnership

                                        interests under the existing

                                        available guidelines.

                              (14) Regardless of the possible arguments

                                   regarding why LLC members should not be

                                   treated as holders of limited liability

                                   interests, until there is clarification

                                   caution would dictate that any LLC

                                   member desiring to avoid losses being

                                   characterized as passive should have at

                                   least 500 hours of activity or meet one

                                   of the other two more restrictive tests.

                                   Those desiring to ensure that losses

                                   will be treated as passive should make

                                   sure that they do not exceed 100 hours

                                   of participation and avoid any of the 7

                                   other tests.

                    3.   For further confusion on this subject, see the

                         discussion of "limited entrepreneur" under the
                         topic of "Agriculture", below.  This concept,

                         introduced in IRC 464, defines a "limited

                         entrepreneur" as a person who:

                              (A) has an interest in an enterprise other

                              than as a limited           partner, and

                              (B) does not actively participate in the

                              management of such enterprise.

          V.   Use In Real Estate Industry

               A.   General

                    1.   LLCs have many favorable attributes useful in real

                         estate transactions.  Some of them are:

                         a.   limited liability for all members

                         b.   flow through of items of income, expense,

                              etc. to members

                         c.   ability to distribute out property to members

                              without recognition of gain (even if property

                              is highly appreciated)

                         d.   No double taxation

                         e.   may be able to transfer future interest in

                              profits to member solely for services without

                              recognition of gain

                         f.   Avoids full disclosure of owners in public

                              records (183.0202 Wis. Stat)

                    2.   They also have some disadvantages:

                         a.   An LLC's lack of continuity of life makes it

                              difficult to use if there are a large number

                              of members

                         b.   Some title insurers may not have fully

                              developed systems for dealing with real

                              property transactions involving LLCs,


                              (1)  specifically designating an LLC as such

                                   on the record

                              (2)  determining the authority of members to

                                   convey and encumber real estate

                              (3)  determining the proper handling of LLCs

                                   operating under a fictitious name or

                                   assumed name

                         c.   Significant issues may exist regarding title

                              to real property or personal property, and

                              authority to transfer it, when an LLC desires

                              to buy or sell real estate in a state which

                              has no LLC statute.

                         d.   There are issues regarding whether a member

                              is "at risk" under IRC 465.  See discussion,

                              above, regarding "at risk" issues.

               B.   Renting

                         a.   Can an LLC member qualify to use up to

                              $25,000 of passive activity losses

                              attributable to rental real estate in which

                              they "actively" participate.  IRC 469(i)

                              (1)  As discussed above, IRC 469 provides

                                   that for certain specified persons and

                                   entities, passive activity losses and

                                   credits will not be allowed. IRC


                              (2)  IRC 469(c(2), makes it clear that

                                   "Except as provided in paragraph (7),

                                   the term "passive activity" includes any

                                   rental activity.

                              (3)  However, even though rental real estate

                                   activities are passive activities,

                                   natural persons may use up to $25,000 of

                                   such losses if they actively

                                   participate.  IRC 469(i).

                              (4)  IRC 469(i)(6)(C) provides that, except

                                   as provided in regulations, "no interest

                                   as a limited partner in a limited

                                   partnership shall be treated as an

                                   interest with respect to which the

                                   taxpayer actively participates."  No

                                   regulations under this section, however,

                                   have been issued. See Treas. Reg.1.469-9


                              (5)  So, the determination of whether $25,000

                                   of such losses are available to members

                                   of an LLC turns on what the meaning of a

                                   "limited partnership interest in a

                                   limited partnership' means within the

                                   context of IRC 469(h).

                              (6)  While the definition of "limited

                                   liability interest" contained in Treas.

                                   Reg. 1.469-5T(e), discussed extensively

                                   above in connection with passive

                                   activities, was specifically limited by

                                   IRS to only subsections (e) and h(2) of

                                   that regulation and does not cause a

                                   problem in applying subsection (i), the

                                   statutory language upon which that

                                   regulation is based is still of concern

                                   as is the language of Rev.Proc. 89-12.

                                   (The language found in IRC 469(h)(2)

                                   suggesting that limited partnership

                                   interests are not interests in which

                                   there can be "material participation" is

                                   identical with that found in IRC

                                   469(i)(6)(c) which provides that such

                                   interests may not be interests in which

                                   there can be "active participation".

                              (7)  Thus, there is even less clarity with

                                   regard to what the "correct" treatment

                                   of a member of an LLC is with regard to

                                   the "active participation" requirement.

                                   (a)  On the one hand, the lack of a

                                        specific regulation defining a

                                        limited partnership interest in a

                                        manner which encompass LLCs is

                                        helpful because an LLC is not,

                                        absent such definition, what is

                                        typically thought of as a limited

                                        partnership.  Furthermore, the

                                        meritorious counter arguments and

                                        policy considerations used to

                                        support the proposition that LLC

                                        members should be treated in a

                                        manner similar to Subchapter S

                                        shareholders, not limited partners,

                                        have as much merit in connection

                                        with the "active participation"

                                        standard as they do in connection

                                        with the "material participation"


                                   (b)  On the other hand, the legislative

                                        history of 469 suggests that

                                        Congress may have been concerned

                                        about the potential tax shelter

                                        aspects of both limited

                                        partnerships and LLCs when they

                                        drafted 469(h), dealing with

                                        material participation, and the use

                                        of the identical statutory language

                                        would suggest an identical

                                        legislative intent.

                                   (c)  While there is, perhaps, a

                                        reasonable basis for taking the

                                        position that LLC members may claim

                                        up to $25,000 of deductions under

                                        IRC 469(i), such members should be

                                        aware that IRS may disagree and

                                        that there is uncertainty as to how

                                        a court may resolve the issue.

                         b.   Will LLC members qualify for the new (1993)

                              relief from the "passive activity" rules

                              relating to rental real estate which Congress

                              granted people actively engaged in the real

                              estate industry?

                              (1)  If an LLC member interest is a limited

                                   partnership interest, the use of an LLC

                                   may be undesirable for those engaged in

                                   real estate rental as their primary


                              (2)  As adopted, IRC 469 (c)(7) provides


                                   (a)  if more than one-half of the

                                        personal services performed in

                                        trades or businesses by a taxpayer

                                        are performed in real estate

                                        businesses in which the taxpayer

                                        materially participates, and

                                   (b)  during the year the taxpayer

                                        performs more than 750 hours of

                                        services in real property trades or

                                        businesses in which the taxpayer

                                        materially participates, then that

                                        taxpayer's rental real estate

                                        activities for the year are not

                                        automatically characterized as

                                        passive activities since IRC

                                        469(c)(2) (making rental activities

                                        passive) will not apply to it.

                                        (Hereinafter called the "Service & Hour Test".)

                              (3)  A real property trade or business is

                                   defined to include development,

                                   redevelopment, construction, reconstruc-

                                   tion, acquisition, conversion, rental,

                                   operation, management, leasing, or

                                   brokerage trade or business.  IRC


                                   (a)  In the case of a joint return, at

                                        least one spouse must separately

                                        meet the service criteria.  IRC


                                   (b)  Services as an employee in real

                                        property trades or businesses will

                                        not be counted unless the employee

                                        is a 5-percent owner in the

                                        employer as described in IRC

                                        416(c)(1)(B).  IRC 469(c)(7). 

                                        (See discussion below).

                                   (c)  The new law is to be applied to

                                        each interest of the taxpayer in

                                        rental real estate as if it were a

                                        separate activity unless the

                                        taxpayer elects to treat all of the

                                        interests as one activity.

                              (4)  IRC 469(c)(7)(A) specifically provides

                                   that it is not to be construed as

                                   affecting the determination of whether

                                   the taxpayer materially participates

                                   with respect to any interest in a

                                   limited partnership as a limited


                                   (a)  This suggests that the standard 3

                                        tests regarding material

                                        participation which are generally

                                        applied to limited partners (eg.

                                        500 hour per year) are to still

                                        apply to limited partners in

                                        determining whether they materially

                                        participate in the activity.

                                        i)   The discussions above

                                             pertaining to "material

                                             participation" and "active

                                             participation" as they apply

                                             to member interests in LLCs

                                             are applicable.

                                   (b)  However, the issue of whether a

                                        member's interest in an LLC is a

                                        limited partnership interest may be

                                        of even more important since the

                                        750 hour criteria and one-half time

                                        requirements are only measured

                                        against interests in which the

                                        taxpayer "materially participates".

                                        IRC 469(c)(7)(A). The significance

                                        of the requirement is potentially

                                        compounded because of an ambiguity

                                        in the statute.

                                        i)   While the taxpayer may

                                             aggregate the interests for

                                             purposes of applying the

                                             passive loss rule (IRC

                                             469(c)(7)(A)), the statute is

                                             ambiguous as to whether they

                                             may be aggregated for purposes

                                             of testing whether a taxpayer

                                             is a qualifying person - one

                                             who meets the Service & Hour


                                        ii)  The ambiguity exists because

                                             provision 469(c)(7)(B)

                                             provides that "This paragraph

                                             shall apply to a taxpayer if"

                                             -- the Service & Hour Test is

                                             met.  IRC 469(c)(7)(A)

                                             provides that the application

                                             of the aggregation provision

                                             in 469(c)(7)(A) only applies

                                             "If this paragraph applies to

                                             any taxpayer . . .."  This

                                             suggests that the requirements

                                             of the Service & Hour Test

                                             must be tested and satisfied

                                             before the right to aggregate

                                             arises.  However, the

                                             ambiguity exists because the

                                             reference to "this paragraph"

                                             which appears in both sub-

                                             paragraphs (A) and (B) are

                                             phrased in a manner such that

                                             they may apply to all of IRC


                                             a)   Thus, if a person had 4

                                                  limited partnership

                                                  interests and worked 450

                                                  hours each year in

                                                  connection with each

                                                  interest, if the

                                                  aggregation rule could

                                                  not be applied to test

                                                  whether the Service &

                                                  Hour Test were satisfied,

                                                  the taxpayer would fail

                                                  the Service & Hour Test

                                                  even if all of the

                                                  activities were real

                                                  estate activities in

                                                  which the taxpayer was

                                                  involved full time.  The

                                                  result seems to be

                                                  different if one spent

                                                  900 hours in each of two

                                                  activities. Perhaps the

                                                  statute will be construed

                                                  as allowing the

                                                  aggregation of interests

                                                  for the purpose of

                                                  satisfying the Service &

                                                  Hour Test.

                                        iii) If the statute applies, the

                                             ability to aggregate the

                                             interests would seem to allow

                                             the combining of services

                                             performed in different

                                             capacities for the purpose of

                                             satisfying the material

                                             participation test (500 hours


                         c.   Is there any particular advantage to using an

                              LLC if we want to have "personal services of

                              an employee" be considered as qualify for the

                              special 1993 relief granted under new IRC 469

                              (c)(7)(D)(ii) (which was discussed in the

                              immediately preceding section.)

                              (1)  As stated above, an employee's

                                   performance of services for his/her

                                   employer will not be taken into account

                                   in determining the amount of his/her

                                   participation in real estate activities

                                   which will qualify the person for the

                                   1993 relief unless the employee is a 5-

                                   percent owner of the employer.  IRC

                                   469(c)(7)(D)(ii).  This provision refers

                                   to the definition of 5-percent owner

                                   under IRC 416(i)(1)(B), which pertains

                                   to both employees of corporations and

                                   employees of non-corporate enterprises

                                   in which the "employee" owns more than

                                   five percent of the capital or profits

                                   of the organization.  IRC


                              (2)  At least one commentator has indicated

                                   that there may be an argument that a

                                   "partner" is not an employee and, thus,

                                   the use of an LLC would eliminate this

                                   requirement for members of an LLC.

                                   However, this argument seems to beg the

                                   question in that the language of IRC

                                   section 416(i)(1(B) talks of profits and

                                   capital interests in non-corporate

                                   entities and such terminology is

                                   consistent with partnerships.

               C.   Low Income Housing

                    1.   Low Income Housing

                         a.   IRC 42(h)(5)(A) requires each state to

                              allocate at least ten percent of their low -

                              income housing credits to projects in which

                              qualified non-profit organizations materially

                              participate.  In order to constitute a

                              qualified low income housing project, "a

                              qualified non-profit organization must own an

                              interest in the project (directly or through

                              a partnership) and materially participate

                              (within the meaning of 469(h)) in the

                              development and operation of the project

                              throughout the compliance period."

                              (1)  Can an LLC be used to meet this


                              (2)  Will the various departments of housing

                                   and community development be

                                   sufficiently knowledgeable to draft

                                   rules which take into consideration the

                                   IRC definitions?

                                   (a)  How will those departments even

                                        know what the classification of the

                                        entity is?

                                   (b)  What happens if the classification

                                        changes in the middle of the


               D.   Miscellaneous

                    1.   Real Estate Transfer Fees - Statute was modified

                         when LLC Act passed

                         a.   "Mergers of corporation" now includes

                              combining 2 or more LLCs under a plan of

                              merger, 77.21 (le), Wis.  Stats.

                         b.   Transfer fee exemption for conveyances of

                              real property between an LLC and one or more

                              of its members if all of the members are

                              related to each other as spouses, lineal

                              ascendants, lineal descendants, siblings, or

                              spouses of siblings and if the transfer is

                              for no consideration other than the

                              assumption of debt or an interest in an LLC.

                              77.25(15s), Wis. Stats.

                    2.   Title Insurance Problem - In some states, an LLC,

                         like a general partnership, may have difficulty

                         obtaining meaningful title insurance commitments,

                         and there may be difficulty with regard to certain

                         other types of insurance, because a change in the

                         membership of the general partnership or the LLC

                         can result in a technical dissolution, with a

                         concurrent change in the identity of the

                         partnership and, thus, the disappearance of the

                         named insured. (An endorsement is frequently

                         available to eliminate the problem.)

          VI.  Natural Resources

               A.   Not surprisingly, the LLC form has significant benefits

                    as a form of organization for development of oil, gas,

                    and mineral properties. (Remember, Wyoming was the

                    first state to adopt an LLC statute and that was for

                    the benefit of an oil and gas company.)  In addition to

                    the benefits associated with pass-through tax entities,

                    the LLC may provide some additional benefits in oil,

                    gas and other mineral transactions.

               B.   Oil, gas and other mineral properties may be held in a

                    variety of forms. However, the two most common

                    ownership arrangements are undivided interests as co-

                    tenants and partnership.

                    1.   Undivided co-tenant arrangements are frequently

                         used when the property is held under a joint

                         operating agreement.  The primary advantage of

                         this arrangement is that the parties are usually

                         only severally liable for their proportionate

                         share of claims with respect to the property,

                         instead of jointly and severally liable.

                    2.   A properly structured LLC should be able to pass

                         through tax benefits with results substantially

                         the same as an undivided co-tenancy or a

                         partnership. would. Furthermore, reasonable

                         allocations of intangible drilling costs and other

                         items may be made among the members (Subject to

                         IRC 704).

               C.   A "Farm Out" is a name given to a fairly common type of

                    arrangement pursuant to which an operator will receive

                    an interest in the operation for little or no capital


                    1.   The arrangement may typically be implemented

                         either through a co-tenancy arrangement or a


                    2.   Since an LLC can issue an interest for services

                         and/or a written promise for future services, it

                         can accomplish the same objectives as a typical

                         farm out.  Furthermore, the fact that a profits

                         interest in the LLC may be granted in exchange for

                         future services without an immediate income tax

                         impact makes the use of an LLC even more


               D.   The limitations on the use of passive activity losses

                    are not applicable to most common oil and gas

                    arrangements because IRC 469(c)(3) provides that

                    working interests in any oil and gas property which the

                    taxpayer holds directly or through an entity which does

                    not limit the liability of the taxpayer with respect to

                    such interest, does not constitute a passive activity.

                    1.   However, since an LLC will limit the liability of

                         the members, the working interest exception will

                         not be applicable and the owners will have to meet

                         all of the standard requirements applicable to

                         LLCs with regard to complying with or avoiding

                         active or material participation in the venture.

                         The entire discussion set forth with regard to

                         LLCs will be applicable.

               E.   Election Out of Subchapter K.

                    1.   Treas. Reg. 1.761-2 provides that owners of an

                         organization used for the joint production,

                         extraction, or use of property, but not for the

                         purpose of selling services or property produced

                         or extracted may elect out of the Subchapter K

                         provisions.  Often times, oil, gas and other

                         mineral extraction will be the subject of a joint

                         operating agreement for the joint production,

                         extraction, or use of property.

                    2.   More particularly, Treas. Reg. 1.761-2 provides in

                         section (a)(3) that:

                              Where the participants in the joint

                              production, extraction, or use of property:

                                   (i) Own the property as co-owners,

                                   either in fee or under lease or other

                                   form of contract granting exclusive

                                   operating rights, and

                                   (ii) Reserve the right separately to

                                   take in kind or dispose of their shares

                                   of any property produced, extracted, or

                                   used, and

                                   (iii) Do not jointly sell services or

                                   the property produced or extracted,

                                   although each separate participant may

                                   delegate authority to sell his share of

                                   the property produced or extracted for

                                   the time being for his account, but not

                                   for a period of time in excess of the

                                   minimum needs of the industry, and in no

                                   event for more than 1 year, then such

                                   group may be excluded from the

                                   application of the provisions of

                                   subchapter K under the rules set forth

                                   in paragraph (b) of this section.

                                   However, the preceding sentence does not

                                   apply to any unincorporated organization

                                   one of whose principal purposes is

                                   recycling, manufacturing, or processing

                                   for persons who are not members of the


                    3.   There is no clear answer regarding whether or not

                         an LLC may elect out of Subchapter K.  Presumably,

                         if all of the criteria were met, an election out
                         should be possible.

               F.   Substantive state laws regarding the ownership of real

                    estate, particularly out of state properties, and the

                    taxation of co-owners or partners by multiple states is

                    more well settled when it comes to co-tenancy

                    relationships and partnerships than it is with regard

                    to LLCs.

          VII. Agriculture

               A.   LLCs provide some advantages for the conduct of farm or

                    ranch operations in that they offer the typical

                    advantages of partnership ownership with the positive

                    attribute of limited liability.  (Some of the

                    advantageous partnership tax attributes are: pass-

                    through of items of income, loss, etc., no double

                    taxation, and the ability to distributed highly

                    appreciated assets in a non-taxable transaction).

                    Additionally, some advantageous estate planning

                    opportunities also make the arrangement desirable for

                    some farm and ranch owners.

               B.   As a matter of public policy, however, some states

                    restrict the ownership of agricultural land so that its

                    acquisition by non-U.S. citizens or large corporations

                    is limited.

                    1.   Wisconsin provides in Wis. Stat. 182 that

                         corporations and trusts may not own land on which

                         to carry on the production of dairy products not

                         including the processing of such dairy products;

                         the production of cattle, hogs and sheep; and the

                         production of wheat, field corn, barley, oats,

                         rye, hay, pasture,  soybeans, millet and sorghum

                         unless it has 15 or fewer shareholders or

                         beneficiaries, 2 classes of stock or less, and all

                         of its shareholders or beneficiaries are natural

                         persons or estates.  Many exceptions are

                         incorporated into the statute to cover

                         grandfathered land, research activities, pollution

                         control activities etc.

                         a.   The prohibitions under Wis. Stat. 182 do not,

                              however, appear to apply to either limited

                              partnerships or LLCs. 

                    2.   Wisconsin provides in Wis. Stat. 710.022

                         restrictions on the, direct or indirect,

                         acquisition, ownership, or holding of any

                         interest, in more than 640 acres of land (except

                         an interest used to secure repayment of a debt

                         incurred in good faith) by:

(1)        non-resident aliens,

                              (2)  corporations not created under the laws

                                   of the United States or a state of the

                                   United States,

                              (3)  corporations, LLCs, partnerships or

                                   associations having more than 20% of

                                   their stock, securities or other indicia

                                   of ownership held or owned by persons or

                                   entities described above, and

                              (4)  trusts having more than 20% of the value

                                   of their assets held for the benefit of

                                   persons or entities described above.

                         b.   Exceptions are created for certain

                              inheritances, treaties with foreign nations,

                              railroads, pipelines, and certain mining,

                              mineral exploration, and manufacturing


                         c.   The statute provides procedures for the

                              divestiture of land exceeding 640 acres if in

                              violation of the statute and provides

                              penalties for its violation, including

                              forfeiture of the land to the State.

                         d.   Thus, an LLC may be the owner of less than

                              640 acres of Wisconsin land if more than 20%

                              of its ownership interests are held by

                              persons or entities described above or an

                              unrestricted quantity of Wisconsin land if

                              the 20% restriction is met.

                              (1)  While the 20% requirement as applied to

                                   trusts talks of the value of the assets,

                                   the language regarding LLCs is less

                                   clear in that it refers to stock,

                                   securities, and other indicia of

                                   ownership which, in marginal situations,

                                   may be difficult to ascertain because of

                                   the flexibility of ownership

                                   arrangements of LLCs and no indication

                                   of whether any management rights of a

                                   member are necessary to constitute an

                                   ownership interest for purposes of this

                                   statute. (Is an interest acquired by

                                   assignment an ownership interest?)

               C.   Certain federal tax issues also arise in connection

                    with the use of LLCs in Agriculture.  (In many respects

                    they present the same types of issues which are

                    discussed extensively with regard to passive losses.

                    It is suggested that those materials be reviewed for

                    further insight into these issues.)

                    1.   IRC 464 requires that, in the case of a farming

                         syndicate, amounts paid for feed, seed,
                         fertilizer, or other similar farm supplies may

                         only be deducted in the taxable year in which the

                         items are actually used or consumed, or, such

                         later date as they might otherwise be deductible.

                         (No prepaid expense deduction.)

                    2.   IRC 464 also provides that in the case of a

                         farming syndicate, the cost of poultry acquired

                         for use in a trade or business must be capitalized

                         and the cost of poultry purchased for resale may

                         only be deducted in the year in which they are

                         sold or disposed of.

                    3.   It is in the definition of a farming syndicate

                         found in IRC 464(c) that issues arise regarding an


                    4.   A farming syndicate is defined as a partnership or

                         other enterprise (other than a corporation which

                         is not an S corporation) engaged in the trade or

                         business of farming, if interests in the

                         enterprise were offered for sale in a format where

                         they had to be registered as a security with a

                         state or the Federal government, or, as set forth

                         in IRC 464(1)(B):

                              (B) a partnership or any other enterprise

                              other than a corporation which is not an S

                              corporation engaged in the trade or business

                              of farming, if more than 35 percent of the

                              losses during any period are allocable to

                              limited partners or limited entrepreneurs.

                    5.   While limited partner is not defined in the

                         statute, limited entrepreneur is defined as a

                         person who:

                              (A) has an interest in an enterprise other

                              than as a limited partner, and

                              (B) does not actively participate in the

                              management of such enterprise.

                    6.   Thus, the statute recognizes a category of

                         interest holder who is not a limited partner, may

                         or may not be a general partner, but nonetheless

                         is an owner of an interest in the enterprise.  On

                         the face of the statute:

                         a.   A member of a manager managed LLC could

                              readily fall within the category if they are

                              not already in the "limited partner"


                         b.   A member of a member managed LLC could fall

                              within the definition if the members had an

                              informal or formal relationship, established
                              in the operating agreement or otherwise,

                              whereby the particular member did not

                              actually exercise their authority to

                              participate in management and, thus, did not

                              meet the "actively participate" requirement

                              for inclusion within the definition.

                         c.   Technically, an assignee of an interest in an

                              LLC could be a limited entrepreneur, as could

                              the estate of a deceased member, etc.

                    7.   However, for the purposes of IRC 464(1)(B), the

                         IRC provides that the following are not interests

                         held by a limited partner or a limited    


                                   (A) in the case of any individual who

                                   has actively participated (for a period

                                   of not less than 5 years) in the

                                   management of any trade or business of

                                   farming, any interest in a partnership

                                   or other enterprise which is

                                   attributable to such active


                              (B) in the case of any individual whose

                              principal residence is on a farm, any

                              partnership or other enterprise engaged in

                              the trade or business of farming such farm,

                              (C) in the case of any individual who is

                              actively participating in the management of

                              any trade or business of farming or who is an

                              individual who is described in subparagraph

                              (A) or (B), any participation in the further

                              processing of livestock which was raised in

                              such trade or business (or in the trade or

                              business referred to in subparagraph (A) or


                              (D) in the case of an individual whose

                              principal business activity involves active

                              participation in the management of a trade or

                              business of farming, any interest in any

                              other trade or business of farming, and,

                              (E) any interest held by a member of the

                              family (or a spouse of any such member) or a

                              grandparent of an individual described in

                              subparagraph (A), (B), (C), or (D) if the

                              interest in the partnership or the enterprise

                              is attributable to the active participation

                              of the individual described in subparagraph

                              (A), (B), (C), or (D).

                    8.   With the exception of provision (E), which brings

                         family members of those actively engaged in
                         farming within the purview of the exceptions to

                         treatment as a limited partner or limited

                         entrepreneur, the tests are in many respects like

                         those applicable to the passive loss rules and the

                         phrase "actively engaged", is strikingly similar,

                         but not identical to, the "active participation"

                         requirement set forth in the passive loss rules.

                         a.   The existence of a category of "limited

                              entrepreneur" clearly indicates that Congress

                              anticipated a category of owner which is

                              perhaps neither a limited partner nor a

                              general partner (or, at least, may not be

                              "actively" exercising their rights to manage

                              as a general partner.)  The recognition of

                              this category suggests that, for purposes of

                              the passive loss rules and other rules

                              influenced by the treatment of an LLC owner

                              as a limited partner, LLC owners may not be

                              limited partners because they may instead be

                              "limited entrepreneurs" even if they are not

                              general partners.  However, the situations is

                              certainly not clear.

                         b.   All of the debates regarding passive losses,

                              material participation, active participation,

                              etc. should be considered with regard to the

                              application of IRC 464.

                         c.   Where the relationship of an LLC member is

                              not clearly within the ordinary meaning of

                              the phrase "Limited Partner" and it is not

                              clearly within the definition of Limited

                              Entrepreneur which is contained in the

                              statute, there seems to be a reasonable basis

                              for concluding that the restrictive

                              provisions are not applicable to owners of

                              interests in LLCs.  However, the owner of the

                              interest must be cautioned regarding the

                              confusion in the area and the fact that IRS

                              may not agree with the position.  for

                              planning purposes, a more conservative

                              approach should be taken so that persons

                              desiring to fall outside of the Limited

                              Entrepreneur category should actively

                              participate in the management of the

                              enterprise and/or meet one of the exceptions

                              to it.  As it may not be possible to escape

                              the "limited partner" categorization, a safe

                              harbor in one of the exceptions would be the

                              best approach.

          VIII.     Venture Capital

               A.   Businesses Requiring Outside Investors

                    1.   LLCs lend themselves extremely well to needs of

                         those desiring to raise capital as they can be

                         made to meet the needs of all of the parties.

                    2.   Investors can:

                         a.   receive limited liability, thus, limiting

                              their economic exposure

                         b.   obtain flow-through tax treatment

                         c.   retain an element of control over the

                              business in the event it begins to fail

                              (1)  as limited partners they could not

                                   actively participate in the event the

                                   business were failing without becoming

                                   liable as a general partner

                              (2)  as shareholders, they might not be able

                                   to override the decisions of the board

                                   of directors unless the entity qualified

                                   as a statutory "close corporation"

                    3.   Income and other tax and non-tax attributes can be

                         allocated (if consistent with IRC 704) to attract

                         the needed personnel and investors to make the

                         transaction work:

                              (1)  more than one class of ownership

                                   interest can be created in the operating

                                   agreement to attract employees, passive

                                   investors, and investors desiring to

                                   participate in management

                              (2)  the interests can be structured so that

                                   their characteristics vary based upon

                                   the happening of future events so that:

                                   (a)  the rights and obligations of the

                                        original creators, the lenders,

                                        employees, and underwriters, can

                                        all be adjusted to accommodate

                                        changes in the nature of their


                                   (b)  financial benefits can vary with

                                        performance so that those

                                        responsible for positive or

                                        negative results can obtain or lose

                                        economic benefits and control as


                                   (c)  control can be delivered to the

                                        investors if the venture looks like

                                        it will fail without different


                    4.   In the event that very large numbers of investors

                         are required, an LLC could be created which has as

                         its members several limited partnerships each of

                         which has many members.  Such an approach may help

                         reduce the possibility of an event of dissolution

                         or dissociation.

                         a.   This is particularly important as the LLC may

                              be treated as having both limited liability

                              and centralized management.  Thus, it must

                              avoid free transferability of interests and

                              continuity of life to obtain classification

                              as a partnership.

                    5.   In very complex transactions, the LLC operating

                         agreements, although complex, may still be far

                         less complicated than those needed in a corporate

                         enterprise having several classes of stock.

                    6.   Some commentators believe that the securities laws

                         may better protect investors, whether active or

                         passive,  although they speculate that promoters

                         may find this to be a disadvantageous.

                    7.   As previously discussed, the primary impediment to

                         the use of LLCs for multi-state transactions is

                         the uncertainty of their treatment in states which

                         have not adopted LLC statutes.  Only time will

                         cure this deficiency as a body of case law

                         develops and other states adopt LLC statutes.

                    8.   The passive loss rule problems discussed above,

                         will, of course be present.  Investors seeking to

                         ensure that losses are not "passive" will have to

                         make sure that they participate for at least 500

                         hour.  Those investors desiring income to be

                         treated as passive will have to make sure that

                         their participation in the enterprise does not

                         rise to the level of being "significant".

               B.   Leveraged Buy Outs

                    1.   Under circumstances where a leveraged buy-out

                         might be considered, the conversion of the company

                         to an LLC might allow the infusion of capital or

                         other changes which are desired by the buyer

                         and/or seller while avoiding the incurring of

                         large amounts of debt.  In most instances, the

                         flexibility of the LLC will allow it to adopt the

                         same control, payment and tax results which might

                         have been derived form an LBO.  In many cases, the
                         use of an LLC might actually better suit the needs

                         of the buyers and the sellers.

          IX.  Foreign Investment & Operations

               A.   LLCs are attractive vehicles for foreign investment:

                    1.   There is generally no limitation on the nature of

                         the investors

                         a.   Watch out, however, for  restrictions imposed

                              by licensing, national security, or other

                              public policy concerns - eg. restrictions on

                              foreign ownership of land.

                    2.   The LLC is a type of enterprise familiar to

                         foreign investors

                    3.   As foreign LLC type entities are recognized in the

                         U.S., U.S. LLCs may be recognized in other

                         countries and may be able to carry out business

                         activities in those countries.

                    4.   The LLC offers limited liability with enough

                         flexibility to deal with the economic and tax

                         concerns of members with international concerns.

                    5.   A nonresident alien investor in an LLC might

                         undertake the investment directly, through

                         participation of a foreign corporation, or through

                         a domestic corporation.  The application of the

                         U.S. withholding tax statutes, the income tax

                         return filing statutes, the branch profits tax

                         statutes, and various treaties will all be

                         effected by the format of the investment.  the

                         taxation of the transaction by the foreign country

                         is also likely to be effected by the form of the


                    6.   Subchapter S corporations sometimes conduct

                         foreign operations through the use of a C

                         corporation in which it has less than an 80%

                         interest. (Frequently, its shareholders own the

                         remaining interests.)  an LLC would be an

                         attractive substitute and the S corporation might

                         be able to own nearly 99% of it.

          X.   Corporate Joint Ventures

               A.   Two or more  corporations will sometimes desire to pool

                    their efforts to accomplish a joint objective.

               B.   In the past such objectives were accomplished through

                    the joint ownership of a corporation, a partnership, a

                    limited partnership, a lease, or some type of financing


               C.   Each format, however, has deficiencies which make the

                    use of an LLC desirable.

                    1.   The use of a jointly owned corporation provided

                         limited liability and allowed active participation

                         of both owners. However, since neither parent

                         typically owned 80% or more of the stock,

                         consolidated returns could not be filed and the

                         dividends received deduction did not fully avoid

                         double taxation of some of the revenue.

                         Distributions to non-corporate joint venturers

                         were all subject to double taxation.  Similarly,

                         gain was recognized upon the distribution of

                         appreciated assets at the conclusion of the

                         venture by all of the venturers.  While special

                         purpose subsidiary corporations could be created,

                         veil piercing issues might well arise and limited

                         liability would be sacrificed.

                    2.   Partnerships solve many of the problems present

                         when a corporation is used.  However, no limited

                         liability is afforded and each venturer runs the

                         risk of liability.  Limited partnerships are

                         usually not useful because either the venturer can

                         participate in management of the venture or have

                         limited liability, but not both.

                    3.   Loan and leasing arrangements can result in

                         arrangements similar to joint ventures with regard

                         to both income and expense sharing an

                         participation in different aspects of management.

                         since there is no new entity, double taxation is

                         not in issue.  However, the presence of an

                         unlimited equity participation arrangement lends

                         itself to recharacterization by the IRS or a state

                         no matter what form is used.

                    4.   LLCs can provide the flow-through tax treatment

                         and limited liability sought after in corporate

                         joint ventures.  Additionally, each venturer can

                         participate in management and non-corporate

                         venturers can receive the same benefits.  Equity

                         participation can be adjusted to suit the needs of

                         the participants.  Some commentators have also

                         asserted that the Hart Scott Rodino Act of 1976

                         may not apply, thus, avoiding delay.  Apparently,

                         the Federal Trade Commission may disagree with

                         this position.

                    5.   Wisconsin does not permit consolidated income tax

                         filings and is in the process of changing the

                         application of the business concentration test in

                         connection with the dividend exclusion.  An LLC

                         may be a preferential solution.

          XI.  Employee Incentive Programs

               A.   LLCs lend themselves to joint ventures with employees

                    for all the same reasons that they are attractive for

                    joint ventures generally.  They afford limited

                    liability, single level taxation, the ability to

                    distribute appreciated assets with immediate taxation,

                    and tremendous flexibility to meet the management and

                    economic needs of both the employer and the employee.

                    Furthermore, even if the employee is in control of the

                    employer, classification as a partnership is still


               B.   The use of an LLC in connection with a joint venture

                    with an employee is particularly attractive, however,

                    because the employee may receive an interest in the

                    future profits of the LLC (from operations and upon the

                    ultimate sale of the business) in exchange for her/his

                    promise to provide future services to the LLC and there

                    will be no immediate taxable event.  Campbell v. Comm.,

                    943 F.2d 815(8th Cir. 1991) and Rev. Proc. 93-27.  But

                    see Diamond v. Comm., 492 F.2d 286 (7th Cir. 1974).

                    Since the employee is frequently only contributing

                    services, an arrangement which does not give the

                    employee an interest in capital is often consistent

                    with the desire of the parties.

               C.   When an owner (employee or otherwise) receives a

                    capital interest in an organization in exchange for

                    future services to it, the fair market value of the

                    interest received will be treated as compensation.  If

                    the interest is subject to a substantial risk of

                    forfeiture, IRC 83 provides that the recipient does not

                    recognize any gain until the risk of forfeiture lapses.

          XII. Family Businesses

               A.   Operations

                    1.   An LLC is an excellent type of entity for a

                         "family business" where the family desires to

                         ensure continued control of the business.

                         a.   Control is retained because LLC statutes,

                              such as Wisconsin's, provide that a member

                              may not transfer his/ her membership interest

                              without the consent of the remaining members.

                              (1)  Since the requirement that the other

                                   members approve any transfer of a member

                                   interest is the default position,

                                   lengthy negotiations may not be


                    2.   Since a member may assign his/her economic

                         interests in the LLC without consent of the other

                         members, some flexibility with regard to life time
                         gift giving etc. exists where a voice in the

                         management of the business is not important. eg. a

                         gift to a child

                    3.   The ability to let younger members of the family

                         (or key personnel) acquire a profits interest in

                         exchange for a contribution of future services

                         also works to the advantage of the family

                         business.  In this manner the long term economic

                         viability of the business is better ensured

                         because of easier management succession than that

                         allowed by corporate entities where it may be more

                         difficult to buy-in.

                    4.   Flexibility with regard to the economic benefits

                         and voting control can be extremely useful in

                         connection with both the operational aspects of

                         the business and the family's dispositive plans.

                    5.   The general tax rules governing family

                         partnerships are, however, applicable to LLCs if

                         the facts warrant their application. (IRC 704(c))

                    6.   Favorable State transfer tax rules also lend

                         themselves to a family business being run in the

                         form of an LLC.

                    7.   If disputes arise and the business must be broken

                         up among different family members, the ability to

                         distribute appreciated assets to family members

                         holding capital interests without recognition of

                         any gain is an important feature.

                    8.   Retirement plans of older members may also be

                         accommodated by the LLC's buying out the interest

                         of the retiring partner.  It should be noted,

                         however, that changes were made in 1993 to IRC

                         section 736 so that there are now significant

                         limitations on the ability to buy out a partner's

                         interest in a partnership in a manner which

                         provides ordinary income to the recipient and a

                         deduction to the partnership.  (That effect may

                         still be obtained in the case of professional

                         partnerships applying IRC 736).

               B.   Estate Planning

                    1.   Family partnerships and corporations have

                         frequently been used for estate planning purposes.

                         LLCs may help to facilitate that planning.

                         a.   While estate freezes have been restricted by

                              changes to the IRC in recent years, many

                              estate planning objectives can still be


                         b.   Older family member owners of corporations,
                              partnerships and LLCs can make annual gifts

                              to younger members of the family and

                              gradually divest themselves of ownership

                              while avoiding gift taxes if the gift has a

                              value which is less than the amount of the

                              gift tax exclusion.

                              (1)  The shifting of these interests from the

                                   older generation to a younger generation

                                   affords both generations some protection

                                   from creditors and, if a majority of the

                                   interests are shifted, allows for the

                                   application of some discounting of the

                                   value of the ownership interests which

                                   are included in the deceased owner's


                              (2)  If gifts are given to younger family

                                   members who are active in a

                                   "partnership" or LLC operated business,

                                   emphasis can be placed on giving

                                   interests in "capital" rather than

                                   profits. (Interests in future profits

                                   can be obtained tax free by the younger

                                   members in exchange for contributions of

                                   future services and any increase in the

                                   future profits interest of a younger has

                                   the effect of decreasing the value of

                                   the profits interest of the older


                         c.   LLCs, while affording the benefits of a

                              partnership also provide limited liability

                              for the family and is, in that respect, more

                              desirable.  For gift giving purposes,

                              certificates in the LLC could be used.

                    2.   Since a properly structured LLC is a partnership

                         for tax purposes, a natural person's basis in

                         his/her interest in the LLC will be stepped upon

                         the death of the owner.  IRC 1014.  If the LLC

                         allows the adjustment of its inside basis under

                         IRC 754, the assets of the LLC will also be

                         stepped up to reduce the amount of gain recognized

                         by the LLC on the disposition of the LLC's assets.

                    3.   There are numerous provisions of the IRC

                         pertaining to estate and gift taxes which impact

                         on family held partnerships and corporations which

                         will also pertain to LLCs.  Provisions such as

                         those found in IRC 2701--2704 are of particular

                         concern because of the characteristics of the LLC.

                         a.   The Wisconsin LLC statute, like most others,

                              grants certain rights to members of LLCs with

                              regard to voting, withdrawing and obtaining

                              payment for the interest, etc.

                         b.   These provisions are particularly important

                              when estate planning for LLCs.  Many of these

                              rights affect issues such as fair market

                              value of the LLC interest and the legitimacy

                              of applying a discount.

                              (1)  For example, although it is common to

                                   discount a minority interest in an

                                   enterprise because of the lack of

                                   marketability of the interest, the

                                   existence of a statutory right to be

                                   bought certainly impacts on the the

                                   argument that there is no market or that

                                   the value should be discounted. Similar

                                   issues arise because of the rights

                                   granted LLC members and the lapse of

                                   those rights (particularly voting


                         c.   For the best discussion of these issues which

                              I located, see section 17.18 to the March

                              1994 supplement to Ribstein and Keatinge on

                              Limited Liability Companies published by

                              Shepard's/McGraw-Hill, Inc. Use these

                              materials cautiously, however, as, at least

                              with regard to income tax issues, some

                              differing opinions may exist with regard to

                              some matters.

          XIII.     Professional Practices

               A.   Professionals have customarily used general

                    partnerships as their entity of choice for carrying on

                    their practices.

               B.   In many instances, accountants, doctors, lawyers and

                    other professionals conducted their practices in

                    partnership form because of ethical requirements of

                    their professions.

               C.   Although resisted at first, states modified their laws

                    and ethics codes to allow professionals to operate from

                    professional or service corporations to take advantage

                    of corporate employee benefit plan rules.

               D.   As partnership employee benefit plan benefits became

                    more similar to those of corporations, the trend toward

                    services corporations slowed.

               E.   More recently, particularly in the context of the

                    failure of some large businesses and their related

                    malpractice claims, professionals, associations, and

                    legislatures have been re-evaluating the limits of

                    professional liability.

                    1.   In some instances, commentators have questioned

                         the public policy which imposes on accountants a

                         level of financial responsibility for malpractice

                         which is different than the financial

                         responsibility imposed upon underwriters in

                         virtually the same transaction.

               F.   Presently, a partner is jointly and severably liable

                    for the debts and obligations of the partnership. As

                    such, he or she is liable for all of the acts of

                    malpractice committed by any member of the partnership.

               G.   With the adoption of service corporations, the

                    professional received some relief from liability on

                    account of general business transactions but remained

                    liable for acts of professional malpractice committed

                    by any member of the firm to the same extent that they

                    would have been liable if operating in a partnership


               H.   As a result of the re-evaluation of the public policy

                    behind various malpractice statutes, many states have

                    used the movement toward LLCs as an opportunity to

                    readdress their malpractice position.  Some states are

                    moving toward a policy of having the LLC itself be

                    liable for any negligent or wrongful act or misconduct

                    committed by one of its members or employees.

                    Individual members would, however, only be personally

                    liable for their own negligence, wrongful act or

                    misconduct or for that of a person under her/his direct

                    supervision and control.  They would not be personally

                    liable for any negligence, wrongful act or misconduct

                    committed by any other member or employee of the LLC

                    who was not under his or her direct supervision or


               I.   In January 1992, Rule 505 of the AICPA Code of

                    Professional Conduct was modified to permit accountants

                    to practice in any form permitted by state law.  A copy

                    of Rule 505 is appears in Appendix B.

               J.   States like Wisconsin, however, still had language in

                    their Administrative Codes or statutes which required

                    accountants to practice only in the form of a

                    proprietorship, partnership or service corporation.

                    Wis. Admin. Code, Accy 1.405, a copy of which appears

                    in Appendix C.

               K.   Proprietorships and partnerships continued to have the

                    joint and several liability for debts and claims which

                    had historically been a part of those forms of

                    business.  The Wisconsin service corporation law, found

                    in Wis. Stat.s 180.1903-1921, provided in section 1915,

                    that professionals practicing in the form of a service

                    corporation had limited liability for debts and

                    contractual obligations of the entity.  However, the

                    statute also provided that the professionals continued
                    to be jointly and severally liable for any legal

                    liability arising from the professional service

                    provided by the corporation.  See Appendix D for an

                    unofficial copy of Wis. Stat. 180.1915.

               L.   Effective June 4, 1994 Wis. Admin. Code, Accy 1.405,

                    was amended to be consistent with the AICPA Rule 505.

                    As revised, CPAs may conduct their practice in any form

                    of entity allowed by law.

               M.   Even without considering differences in potential

                    liability which may exist as a result of practicing a

                    profession from various forms of entities, an LLC would

                    be a good choice for the operation of a professional

                    practice.  It provides the flexibility with regard to

                    economics and management which are needed to

                    accommodate today's varying business and personal

                    styles, as well as the restrictions on the

                    transferability of interests which are consistent with

                    a professional practice.

               N.   If one considers the potential liability benefits which

                    might exist if a professional practice were operated

                    from a LLC, the choice of that form of entity becomes


                    1.   Notwithstanding, the edge that LLCs have in

                         Wisconsin, multi-state operations will have to

                         consider numerous other factors before seriously

                         undertaking a change to an LLC.

               O.   While many of the other professions might be similarly

                    advantaged by operating from an LLC, not all of the

                    professions have been as quick as the accounting

                    profession to seize the opportunity of using an LLC.

                    However, there does seem to be a movement forming which

                    would allow professionals to operate from an LLC.


          XIV. Financial Institutions and Insurers

                    1.   While there appears to be no inherent reason why

                         an LLC could not be used to conduct either a

                         banking or insurance business, the fact is that

                         Wisconsin and most other states do not allow those

                         businesses to be conducted by an LLC or a


                         a.   This may be because of the fact that these

                              entities do not necessarily have a perpetual

                              existence or freely transferable interests if

                              it is seeking to be taxed as a partnership.

                    2.   It should be noted, however, that Texas has now

                         modified its rules to allow the operation of a

                         bank by an LLC and the Office of Controller of the

                         Currency has considered or is considering the

                         application of the national bank lending limit to

                         LLCs.  These events suggest that changes may be

                         forthcoming which would allow the operation of

                         banks and insurance companies by LLCs.

          XV.  Financing

               A.   The fact that LLCs have limited liability and, in most

                    states, including Wisconsin, the assets of the LLC may

                    not be subject to most legal or equitable claims of the

                    creditors of the members (piercing the LLC veil), the

                    LLC lends itself to being an alternative to an off-

                    shore entity in certain types of structured finance

                    transactions, certain types of monetization

                    transactions, and as an entity which might issue short

                    term debt or commercial paper in connection with

                    financing business transactions.

               B.   When used in connection with non-recourse debt, there

                    is minimal risk to members of personal liability in

                    connection with a public offering of debt, even in

                    states in which there is no LLC statute.  


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