Limited Liability Companies
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In summary, a new business form combining corporate limited liability and partnership pass-through taxation is well on its way to becoming the preferred form for conducting business. The new limited liability company possesses many advantages, with few disadvantages, over alternative forms of ownership. With this new business form also comes questions concerning ethical behavior and public relations problems. Over time, these issues will be encountered and further approached by upholding professional and ethical standards and by helping third parties understand the benefits of this new business form. While still growing in recognition and adoption, new limited liability companies have the ability to expand the options of business formations, add a new perspective in accounting for this issue, while also providing benefits for all parties involved with this preferred form of business. A limited liability company is a hybrid business form where the corporate characteristic of owner�s limited liability and the partnership characteristic of pass-through taxation are combined. The number of states permitting this new legal form for conducting business is rapidly expanding. From the beginning of 1993 to the end of 1993, the number of states that have passed legislation permitting the limited liability company legal form has risen from 18 to 36 states. Simply passing a state law providing limited liability company status does not ensure that partnership taxation will exist. According to section 7701(a)(3) of the Internal Revenue Code and related regulations, a business entity will be considered an association and taxed as a corporation if it possesses a majority of the following four characteristics: 1) Continuity of Life 2) Centralized Management 3) Limited Liability 4) Free Transferability of Interests A limited liability company always possesses the characteristic of limited liability and must therefore avoid at least two of the remaining three characteristics. In most limited liability company cases it was found that the two characteristics avoided the most were continuity of life and free transferability of interests. Limited liability company cases are usually determined on an individual basis because of the different tax treatment existing from state to state. Some states have adopted rigid limited liability company statutes while other state have adopted flexible statutes. States allowing centralized management, but not continuity of life or transferability of interests have adopted rigid limited liability rules. The Internal Revenue Service has ruled that the limited liability companies formed in these states are to be treated as partnerships. In contrast, states allowing the adoption of any or all of the corporate characteristics of centralized management, continuity of life, or transferability of interests have adopted flexible limited liability company rules. The Internal Revenue Service has ruled that the limited liability companies formed in these states are to be treated as corporations or partnerships based on individual cases. As most new developments and changes in the business world are encountered for the first time, the issue of ethical considerations also become apparent. What are the effects of changes in business forms, either to limited liability companies or from limited liability companies to another business form? What is an accountant�s responsibility, professionally and ethically, to obtain information discovered, but not voluntarily given, concerning such a change in business form? The following case, taken from West�s Federal Taxation, demonstrates the issue of an accountant�s responsibility to inquire of structure changes.