Tax Arbitrage And Organizational Form: Allocation Flexibility In The Limited Liability Company

Abstract

This paper analyzes whether an allocation of tax items among members of a limited liability company (LLC) will likely be respected by tax authorities. The LLC is a recent creation of state law that provides the liability protection of a corporation and the flexibility of partnership tax law. A present-value test must be satisfied to permit allocations among LLC members that are not proportionate to ownership interests to be respected. A model is developed to measure the present value of after-tax benefits and detriments arising from an LLC allocation, and implications of the availability of tax arbitrage for selection of the LLC organizational form are discussed.