Wyoming enacted the first LLC Act in 1977, creating a hybrid business entity combining partnership features including pass-through taxation with corporate-style limited liability. By the mid-1990s, all 50 states had LLC enabling legislation. Today, over 25% of all U.S. tax filings by business entities are LLCs. As one commentator noted a few years back, LLCs are the “New King of the Hill” among business forms used for privately owned entities.
Professor Susan Pace Hamill, who since 1994 teaches business and tax law at the University of Alabama, was in the vanguard of lawyers who, from the start, understood the significance and potential of this new form of business organization. First in private practice in New York City, then in the Chief Counsel’s Office of the IRS, and ever since in academia, Professor Hamill has been a keen observer, historian, influential voice, and prolific author of law review articles on LLCs and other “biz org” topics, interspersed with a run for legislative office in her home state of Alabama and public interest advocacy challenging that state’s property tax structure on race-based equal protection grounds.
I recently had the pleasure of interviewing Professor Hamill for the Business Divorce Roundtable podcast about her latest law review article published in Volume 51 of the Cumberland Law Review, entitled Some Musings as LLCs Approach the Fifty-Year Milestone. The article discusses the origins of the LLC movement, the transformation (or, as Professor Hamill might put it, mutation) of LLCs to more closely resemble their corporate cousins, and some of the problems on the horizon for LLCs that she believes require federal intervention. From the article’s abstract:
In less than twenty years, limited liability companies, or LLCs, became the fastest growing business organization form in the United States and indisputably emerged in the mainstream alongside corporations and partnerships. In 2017, the most recent year for which IRS Statistics of Income figures were available, 2,696,149 LLCs filed returns with the Internal Revenue Service (the “IRS”). This number represents well over three times the number of LLCs that filed returns in 2000. In 2017, over one-fourth of the more than ten million total business organizations were LLCs, an impressive increase when compared to LLCs accounting for 10% of all business organizations in 2000. Over this period, general and limited partnerships became less significant. Although corporations still accounted for the majority of business organizations filings in 2017, the percentage of business organizations filing as corporations dropped by almost 10% when compared to the 2000 filings, and many of those businesses chose to become corporations before LLCs became widely available and are now stuck there—a situation I describe as the “Hotel California effect.” These figures, along with the explosive growth of LLCs compared to an overall decrease of corporations, predict that the gap between the number of businesses conducted as corporations and LLCs will continue to close in the future.
Primarily aimed at readers who are not experts, this article identifies what makes LLCs so special and how they traveled from obscurity to the mainstream so quickly. It also highlights business law issues and abusive practices exposed by the current use of LLCs and explains why these problems are not caused by LLCs. Finally, this article demystifies the challenges of teaching and understanding LLCs within the framework of all business organizations.
Simply put, LLCs are the first domestic business organization form to combine direct corporate limited liability and partnership tax status. The LLC’s creation and characteristics can be best understood as a dance between state and federal law. Despite broad federal power under the Commerce Clause and business being a quintessential example of interstate commerce, state law authorizes business organization forms and dictates the provisions in each business organization statute, and state courts interpret those laws. When determining the federal income tax consequences to the business organization and its owners, federal tax law largely yields to state law, notwithstanding the spirit of the Supremacy Clause. Business organizations designated by state law as corporations are taxed at both the entity and shareholder levels or, if the corporation qualifies for and properly elects to be taxed as a small business corporation, at the shareholder level under a modified flow-through regime with many restrictions. Business organizations designated by state law as “unincorporated,” including partnerships and LLCs, are almost always taxed as partnerships under a complete flow-through regime free of the many traps that plague corporations.
I know from my own business divorce practice the importance of understanding the nuances of the legislative scheme governing LLCs, the often complex interplay between LLC statutory default rules and operating agreements, and the differences between statutory and judicial treatment of the rights and remedies available to minority members of LLCs, the latter being a topic that draws the pique of Professor Hamill in her article and in the interview.
All of which and more is discussed in a lively conversation with Professor Hamill which you can hear by clicking on the below link.