Navigating LLC Waters

With the advent of limited liability companies in the 1990s, more and more business transactions are being conducted through LLCs taxed as partnerships than through corporations. Compared to state corporate laws, LLC statutes are extremely flexible, readily lending themselves to complicated business transactions. With LLCs more often than not being the entity of choice, the issue that commonly arises is how to properly incentivize key employees with LLC membership interests.

In contrast to grants of stock and stock options, the rules for which have been around for decades and are well entrenched in the tax law, how the Internal Revenue Service treats the award of membership interests in LLCs is far from clear, and this lack of clarity can lead to some rather unintended consequences. The absence of any precise tax rules on the grant of non-corporate equity interests to key employees has in the past lead to unpleasant litigation with the IRS.

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