THE TAX TREATMENT OF LIMITED-LIABILITY COMPANIES - LAW IN SEARCH OF POLICY

Certainty and predictability are sacrificed by the creation of tax incentives for the new and uncertain entity form known as the limited liability company. There is little rationality in suggesting replacement of corporations with limited liability companies. Yet, on April 3, 1995, the Department of Treasury announced that it is considering simplifying the regulations for classifying an entity for tax purposes to allow taxpayers to treat domestic unincorporated business organizations as partnerships or associations (taxable as corporations) on an elective basis. If adopted, this proposal would have broad implications for limited liability companies, which would be treated as partnerships, unless elected otherwise, or the classification was determined by another Internal Revenue Code provision. The tax treatment of limited liability companies has broad implications for the federal revenue. To the extent a business can be conducted through a limited liability company instead of through a corporation, an entire level of tax can be avoided. This Article considers four alternative methods of classification of limited liability companies that could improve upon the Treasury's current classification test set forth in the Treasury regulations. The Article concludes that any of these four methods would be preferable to the Treasury's current method.