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Part II: an Overview of Organizational and Ownership Options Available to Agricultural Enterprises

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Part II: an Overview of Organizational and Ownership Options Available to Agricultural Enterprises A research project from The National Center for Agricultural Law Research and Information of the University of Arkansas • [email protected] • (479) 575-7646 • www.NationalAgLawCenter.org An Agricultural Law Research Article Part II: An Overview of Organizational and Ownership Options Available to Agricultural Enterprises by Carol R. Goforth The National Agricultural Law Center University of Arkansas School of Law 1 University of Arkansas Fayetteville, AR 72701 July 2002 Part II: An Overview of Organizational and Ownership Options Available to Agricultural Enterprises Table of Contents A. Introduction to Part II .......................................................... 3 B. Limited Liability Companies ..................................................... 4 1. Business Law Status .................................................... 4 a. Formation ...................................................... 5 b. The Operating Agreement ......................................... 6 c. Liability of Members .............................................. 7 d. Contributions to an LLC ........................................... 8 e. Management of the LLC ........................................... 8 f. Allocations of Profits and Losses, and Distributions ..................... 11 g. Transferability of Membership Interests .............................. 13 h. Terminating Membership Status .................................... 14 i. Dissolution, Winding Up and Termination ............................. 15 2. Tax Status ........................................................... 16 a. In General .................................................... 16 b. Basis Adjustments ............................................... 17 c. The “at-risk” Rules .............................................. 17 d. Passive Losses ................................................. 18 e. The “Tax Matters” Partner ......................................... 18 f. Self-Employment Taxes ........................................... 19 3. Comparing the LLC with Other Organizational Forms. ......................... 22 C. Corporation ................................................................ 25 1. Business Law Status ................................................... 25 a. Traditional Corporation ........................................... 25 b. Statutory Close Corporation ....................................... 26 c. Formation ..................................................... 28 d. Contributions ................................................... 28 e. The Limits on Shareholder Liability .................................. 29 f. Management of a Corporation ..................................... 31 g. The Rights of a Shareholder to Recognize a Return on the Investment ............................................... 32 h. Transferability of Shares .......................................... 33 i. Termination of the Corporation ..................................... 34 2. Tax Status ........................................................... 35 a. S Corporation .................................................. 35 b. C Corporation .................................................. 36 D Cooperatives ............................................................... 37 1. Business Law Status ................................................... 37 a. Introduction .................................................... 37 b. General Comparison with the Corporate Form of Business ............... 37 c. The Essential Attributes of the Traditional Cooperative .................. 39 d. Ownership and Control of a Cooperative ............................. 40 e. Income Distribution in a Traditional Cooperative ........................ 41 f. Returns on Ownership Capital Are Limited ............................ 43 g. Traditional Financing for Cooperative Operations ...................... 44 h. Value-Added or Next-Generation Cooperatives ........................ 45 2. Tax Status ........................................................... 50 E Conclusion to Part II ......................................................... 52 An Agricultural Law Research Article PART II: AN OVERVIEW OF ORGANIZATIONAL AND OWNERSHIP OPTIONS AVAILABLE TO AGRICULTURAL ENTERPRISES Carol R. Goforth* A. Introduction to Part II This article is the second of two articles that together are designed to provide an overview of the available organizational choices for persons interested in owning and operating an agricultural enterprise. This article will cover limited liability companies, corporations, and cooperatives. The first document in the series examined sole proprietorships, general partnerships, limited liability partnerships (LLPs), limited partnerships and limited liability limited partnerships (LLLPs). As with the first article in this pair of articles, the information provided here is general in nature, and this article does not purport to address the specific rules which apply to each of the options in each of the 50 states. For example, all 50 states have statutes governing the formation and operation of limited liability companies. However, there is considerable variation between the states, so it is difficult to identify specific rules that will apply to every LLC. However, there are general principles which apply to most LLCs, and for most rules there are a limited number of default positions identified in the various state statutes. This article therefore attempts to identify the majority rule and the more prevalent deviations from this position. No attempt has been made to research the law of all 50 states, or to provide citations to all 50 statutes. Rather, as to most issues, the citations provided are to the Uniform or Model Act: in the case of LLCs, the citations are to the Uniform Limited Liability Company Act (U.L.L.C.A.), and for corporations, the citations are to the Model Business Corporation Act (M.B.C.A.). This article therefore focuses primarily on the general rules, even as to corporations, where there is significantly greater uniformity with regard to most of the issues discussed in the following pages. This article is not intended as a substitute for the advice of experienced counsel familiar with the laws of the jurisdiction or jurisdictions in which any proposed agricultural business might operate. The purpose here is to provide general background information, and to offer sufficient insights so that a reader will be able to understand most of the attributes of the business forms discussed here. Because it is possible that this article may be consulted by attorneys as well as those who do not have a legal background, the text will generally be written in a manner which is intended to be understandable by anyone. Footnotes will contain more detailed information and citations that are likely to be of interest primarily to persons who already have a legal background, even if their normal areas of expertise do not include the law applicable to business enterprises. ________________ * Clayton N. Little Professor of Law, University of Arkansas 1 Neither part of this series addresses non-profit organizations or trusts, even though both of these may be employed in connection with certain agricultural operations. Rather, the focus of these materials is on the business forms listed above. As with Part I of this series, both business and tax considerations will be introduced, although the primary focus of this article is on the business law rules applicable to each of the organizational forms considered here. B. Limited Liability Companies 1. Business Law Status The LLC is a creature of statute, recognized in each jurisdiction only by virtue of a legislative enactment. The first statute authorizing domestic LLCs was passed in Wyoming in 1977.1 When the I.R.S. finally concluded in 1988 that limited liability should not be a determinative factor in denying partnership tax status to the new organization, the LLC began to receive significant attention elsewhere.2 Shortly after determining that limited liability would not be a determinative factor in entity classification, the Service issued a public ruling concluding that LLCs organized under the Wyoming LLC Act would be classified as partnerships for federal tax purposes.3 This I.R.S. ruling resulted in a trickle of new legislation which turned into a virtual flood of statutes authorizing the new form of business entity by the early 1990's. In the spring of 1996, the last two states enacted LLC legislation, so that all fifty states, plus the District of Columbia, now permit the formation of LLCs.4 1. Wyo. Stat. §§ 17-15-101 to -136 (1989 & Supp. 1995). 2. Announcement 88-118, 1988-38 I.R.B. (Sept. 19, 1988). This study concluded that the limited liability aspect of LLCs should not, by itself, prevent an LLC from being classified as a partnership for tax purposes. See Turlington & Small, Tax Aspects of Limited Liability Companies, PLI Corporate Law and Practice Course Handbook Series, 805 PLI/Corp. 103 (Feb. 1, 1993). Despite the importance of this conclusion, however, there does not appear to have been any written report or analysis accompanying the simple release which did little more than state the conclusions reached by the Service. 3. Rev. Rul. 88-76, 1988-2 I.R.B. (Sept. 18, 1988). 4. Colorado and Kansas enacted LLC statutes in 1990. Colo. Rev. Stat. §§ 7-80-101 to 7-80-1101 (Supp. 1995); Kan. Stat. Ann. §§ 17-7601 to 17-7656 (1995). Nevada, Texas, Utah and Virginia followed suit in 1991. Nev. Rev. Stat. §§ 86.011 to 86.571 (1991); Tex. Rev. Civ.
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