Advanced LLC Tax Issues

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An LLC is a hybrid between a corporation and a partnership. An LLC can be taxed as a partnership, S or C corporation or a disregarded entity. The IRS established federal default rules in 1997 to simply how an LLC is taxed. One member is a disregarded entity and two members are tax as a partnership. In either situation, you can file form 8832 to have an LLC taxed as a Corporation or form 2553 to be taxed as an S corporation.

One of the subjects that 90% the people who have an LLC do not properly handle the transfer of an LLC interest to another.

As personal property, an LLC interest may be transferred by a bill of sale, assignment, or comparable document. If the interest are documented certificates, like stock certificates, it should be possible to transfer an interest by endorsing the certificate, by granting the power of attorney to the transferee, or by granting a type of power like a stock power. To be effective the transferee must also cause the transfer of the interest to be reflected on the LLC’s books. The transfer must first be approved under the LLC’s requirements (e.g., approval of at least a majority in interest of members). It is recommended that an LLC record the transfer of membership interests in the same fashion as a corporation uses a stock transfer ledger.

This is a key point…the transfer of an interest to a person does not by itself grant the status of a member in the LLC. Rather, the transferee is merely an assignee of certain economic rights unless the other members by a vote approve the transfer of the interest.

The various state acts generally provide that unless the members have otherwise agreed, a membership interest is assignable in whole or in part. Although some statutes may refer to the free assignability of a membership interest, what is actually meant is the free assignability of the financial rights, not governance rights.

Typically, members will want to impose restrictions on assignability, and the operating agreement would provide this language. An operating agreement also should define if the transfer restrictions did not apply to transfers to members, non-members, or both of the LLC.

This may surprise you, but an LLC member can assign his or her interest without anyone’s consent. Although the transferee will be an assignee and NOT a member. Only members can vote and exercise other rights of members, but not an assignee, like a member, may receive distributions of cash or property.

In conclusion, it is very important to read and understand your LLC operating agreement. If you are looking to assign interests and you want to make sure it is done properly, an attorney may be recommended.