Legislature(1993 - 1994)
04/07/1994 08:00 AM House STA
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* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
+ teleconferenced
= bill was previously heard/scheduled
CSSSHB 420: "An Act relating to limited liability companies; and providing for an effective date." CHAIRMAN VEZEY opened SSHB 420 for discussion. REPRESENTATIVE GENE THERRIAULT, SSHB 420 sponsor, read the following sponsor statement: "The limited liability company is a relatively new, hybrid form of business structure that combines the tax advantages of a partnership and the liability safeguards of a corporation. Although a combination of these two business structures is currently allowed in statute through formation of an S corporation, this structure has limitations that are avoided by LLCs. For example, S corporations do not allow ownership by certain types of shareholders. "Under current law, corporate earnings are subject to double taxation throughout the payment of corporate taxes and personal taxes after distribution of dividends. LLCs avoid this double taxation by allowing earnings to flow through to individual owners in the same manner partnership income is handled. Although businesses can be organized through an S corporation to avoid double taxation and encompass some of the advantages of partnerships, they do not enjoy all the advantages of partnerships when it comes to allocating income and deductions. "One of the greatest advantages is, as the name implies, the limited liability offered by the LLC structure. With LLCs as with regular corporations, only the company's assets and not the owner's personal assets, are at risk in business- related lawsuits. In partnerships, so-called limited partners enjoy such protection, but general partners do not. And limited partners face restrictions on how active they can be in the business. LLCs are designed to protect all the members while imposing no limits on their involvement in operation of the business. "Thirty-four states now permit limited liability companies, and passage in most of the remaining states is expected. Wyoming passed the first LLC Act in 1977. Other states slowly followed suit until 1988, when the Internal Revenue Service issued Rev. Rul. 88-76, which classified a Wyoming LLC as a partnership for federal tax purposes, even though none of the members or managers were personally liable for any of the debts of the company. Following the ruling, formation of LLCs burgeoned, with two states adopting LLC Acts in 1990, four in 1991, 10 in 1992 and more than 20 states introducing measures in 1993. "LLCs have tended to be family businesses, professional service firms, venture capital companies, real estate and business start ups I believe the LLC will provide these business owners with an efficient and flexible investment vehicle that allows both limited liability, and federal income tax treatment as a partnership. SSHB 420 is based on a prototype American Bar Association draft, with changes to conform the bill specifically to Alaska." REPRESENTATIVE THERRIAULT stated he provided a proposed CSSSHB 420 for the committee to consider. They have been working extensively with the Alaska Bankers Association and the tax and business law sections from the Alaska Bar Association to "Alaskanize" the language. He noted the length of CSSSHB 420, and stated it includes a large section which outlines how corporations are to be formed and operate in Alaska. Framework for a new business structure is being created, rather than altering existing statutes. Number 613 CHAIRMAN VEZEY commented the "so-called corporate shield has been pierced so many times that it is now like a screen door." Why will an LLC establish a shield protecting individuals from the liability of a business structure of activities. (REPRESENTATIVE OLBERG left the meeting at 8:48 a.m.) Number 622 REPRESENTATIVE THERRIAULT deferred the question to the witnesses at the Anchorage teleconference site who may better answer. He stated CSSSHB 420 would not provide any more of a shield than a corporation. The same level of personal asset protection provided in a corporate structure would now be provided through the LLC structure. LLC structure has the advantage over a corporation, whereby double taxation would not exist. Number 631 CHAIRMAN VEZEY asked how it would differ from a subchapter S corporation. Number 633 REPRESENTATIVE THERRIAULT answered there are restrictions on what type of entities can be shareholders in a subchapter S corporation, which do not apply in the LLC structure. (REPRESENTATIVE OLBERG returned at 8:50 a.m.) Number 642 MIKE MONAGLE, SUPERVISOR, CORPORATE INFORMATION, DIVISION OF BANKING, SECURITIES, AND CORPORATIONS, DEPARTMENT OF COMMERCE & ECONOMIC DEVELOPMENT (DCED), answered questions on CSSSHB 420. He said the DCED participates with the International Association of Corporation Administrators and over the last 10 years LLC legislation has been a real "hot topic" among the states. The IRS has granted more and more private letter rulings and treated the states favorably for tax purposes, therefore there is a rush towards LLC organizations in the last 3-4 years. He noted the anticipation that by the end of 1995 all 50 states will have LLC legislation before them. DCED receives 3-4 inquires a week, from other states, wanting to know if Alaska recognizes the LLC structure. Therefore, he believed business opportunity exists and Alaska businesses will benefit to organize under the LLC structure. Number 661 REPRESENTATIVE ULMER asked how many existing companies in Alaska would shift over to the LLC structure. MR. MONAGLE stated he did not know. He did not believe an existing corporation would switch over because of the difficulty. Large corporations have shareholders and LLCs have managers, or members that manage. Therefore, it would not be feasible to replace boards of directors with one manager, or a group of shareholders to make the decisions. MR. MONAGLE mentioned "ma and pa type corporations," previously formed as an S corporation, may elect to go with a LLC. They would not have as many restrictions. He noted about 1,100 domestic corporations form a year, most of which are small. A fair number of the small corporations would be subchapter corporations devoid the tax situation. Number 681 CHAIRMAN VEZEY clarified subchapter S corporations are established under federal law. MR. MONAGLE affirmed CHAIRMAN VEZEY. Number 685 CHAIRMAN VEZEY questioned if and where they were recognized under Alaska statute. Federal only? MR. MONAGLE responded he believed Department of Revenue recognizes the exemption granted by the IRS. TAPE 94-45, SIDE B Number 000 CHAIRMAN VEZEY, in comparing a subchapter S corporation to an LLC, pointed out the state adopting federal law versus the federal IRS adapting to state law. He questioned if there was not a great deal more uncertainty. Number 014 MR. MONAGLE answered part of the reason there was not an exodus to the LLC structure initially was because of the question as to what the IRS might do. Wyoming being the state with a private letter ruling. He believed there has been no public letter rulings by the IRS granting blanket exemption for LLCs. Number 026 CHAIRMAN VEZEY inquired what he meant by a blanket exemption. Number 027 MR. MONAGLE replied if one formed subchapter S corporation, recognized as tax exempt, the IRS has not said that they will blanket recognize every state that comes forth with a LLC Act. IRS reviews each state and then makes a ruling. He noted this as another reason for not having a mass exodus to the LLC structure. He believed within the next five years the IRS would provide a blanket ruling due their indication. Number 053 CHAIRMAN VEZEY mentioned MR. MONAGLE's statement that they received three-four outside interest calls. He asked weekly or monthly. MR. MONAGLE answered weekly. Number 059 CHAIRMAN VEZEY inquired if three-four viable business enterprises a week would be actually considering entering a vague IRS status, or do they not know what is in Alaska. Number 063 MR. MONAGLE responded they are already formed as a LLC in their own state. They inquire as to how they will be treated in Alaska. Their structure needs to be recognized to not put their limited liability at risk. Number 081 CHAIRMAN VEZEY clarified they are not aware of the Alaska's status. MR. MONAGLE answered most do not know. Most calls are from comptrollers and service companies. Number 086 REPRESENTATIVE ULMER asked what kind of companies are considering doing business in Alaska, whereby LLC status is critical for them. Number 089 MR. MONAGLE replied what kind of business they are is usually not discussed. They question where Alaska's legislation is. Calls come from all over the country. Number 094 REPRESENTATIVE ULMER questioned who is considering coming to Alaska to do business. Number 095 MR. MONAGLE clarified they call to inquire about Alaska's legislation, therefore he was assuming they were doing studies or making business decisions. Number 099 REPRESENTATIVE ULMER questioned if they were discussing the "ma and pa" type businesses. Number 103 MR. MONAGLE replied he did not think so. States that developed LLCs first were those who do a lot of resource development. He mentioned Colorado and Wyoming as examples. He stated most of Alaska's corporations which deal with mineral extraction are Canadian owned. Therefore, if they have already formed a LLC in another state, it would be an attractive alternative to be able to come and enjoy the same protection in Alaska as they do in their own state. (REPRESENTATIVE SANDERS returned to the meeting at 8:59 a.m.) Number 118 REPRESENTATIVE THERRIAULT mentioned his wife is an attorney dealing with business practice in Fairbanks, and she has also had two-three people per month inquire about forming a business and the possible structures they can form under. He believed, by suggestion of their accountant, these people have questioned whether the LLC form is available in Alaska. He stated it was his intent to add the LLC structure to the list of choices. Number 150 BOB MANLEY, WORKING GROUP CHAIRMAN, TAX and BUSINESS LAW SECTIONS, ALASKA STATE BAR ASSOCIATION, commented on CSSSHB 420. He reiterated CSSSHB 420 was drawn from the American Bar Association Prototype Act, with significant influence from the banking community, corporations, and other interested persons. He stated he read in the Wall Street Journal last week, that 38 states have now adopted LLC legislation. He noted the California State Senate just passed LLC legislation by a 39-0 vote and the Governor is expected to sign shortly. MR. MANLEY stated LLCs blend corporate and partnership tax and operational characteristics. LLCs provide a flexible operating system and a federal income tax advantage to the members. LLCS provide a state planning advantage. LLCs facilitate foreign investment, because nonresident aliens may not be subchapter S corporation shareholders. Double taxation is avoided. MR. MANLEY mentioned LLCs will mostly replace subchapter S corporations and partnerships. He directed to the question of how many companies will change over to LLCs. He answered few, if any regular corporations will change over because the transactual and tax cost of changing would be too significant. Some partnerships, however, will change over. MR. MANLEY directed to the question about the uncertainty of tax classification. He answered the IRS does not like to issue blanket rulings. He noted that the Alaska version of the Uniform Limited Partnership Act adopted in 1992, the IRS has still not issued a ruling as to whether it will be classified as a partnership for tax purposes. IRS moves at its own pace and speed. He stated their working group has already opened informal communication with the IRS and they have indicated they will open a revenue ruling project. Therefore, any uncertainty as to tax classification should be resolved promptly. Number 224 CHAIRMAN VEZEY commented under the current corporate structure, the "corporate shield" is getting thin. Corporate officers now go to jail and boards of directors are now held liable. He asked how current structure would compare to shield provided by the LLC structure. Number 238 MR. MANLEY answered he did not believe the LLC would offer any greater shield. While the operating systems may be a little bit different, people will still be "tagged" in some circumstances, for their own individual acts. Number 256 CHAIRMAN VEZEY mentioned anyone who sits on a board of directors, needs to give consideration to a director's liability insurance policy. Number 263 MR. MANLEY responded, "absolutely." Even with a person serving on a nonprofit volunteer board handling significant amounts of money, is very important to maintain liability insurance. He noted Alaska's corporate code allows corporations to indemnify members to the board of directors. LLC structure does likewise. Number 278 CHAIRMAN VEZEY asked if all partners in an LLC would need to carry a partners liability insurance policy. Number 281 MR. MANLEY answered a LLC can be operated either member- managed or manager-managed. In a manager-managed LLC, he believed it would be appropriate for the manager to secure directors and officers insurance or an equivalent. In a member-managed LLC, he believed some businesses may opt not to because they had previously operated with partners without any protection. He noted protection is prudent. Number 300 PETER BRAUTIGAN, CORPORATE SHAREHOLDER, commented on CSSSHB 420 from the Anchorage teleconference site. He stated his practice entails business and transactional tax planning, along with significant estate planning. He sees the LLC as a viable alternative for many clients. LLC structure is being considered in ventures proposed in Alaska that have been organized in other states. LLCs are important for commerce in the long run. There are no limitations as to the number of investors, thereby trusts and other partnerships can be involved in the LLC. LLCs also allow participation in management, which would not regularly be allowed under a limited partnership theory. MR. BRAUTIGAN addressed the question regarding the corporate veil. He answered the LLC would not provide anymore protection for its investors than a corporation already has. Typically, there are numerous clients who do not maintain their corporations, thereby making it more difficult for them to be protected from liability. He noted as long as the corporation is maintained, the corporate veil will protect the investors' personal assets from the liabilities. MR. BRAUTIGAN stated the types of businesses interested in LLCs are entities from other states that have LLC legislation. Specifically, mining ventures, fishing operations, and entities that want to invest through trust or other partnerships. Number 362 CHAIRMAN VEZEY questioned director liability versus LLC partner liability. He stated individual members of boards of directors are held liable particularly for taxes. How would this transfer over to a LLC partnership. Number 370 MR. BRAUTIGAN clarified CHAIRMAN VEZEY was questioning the 100 percent penalty imposed by the IRS, Section 6672 of the Internal Revenue Code. This section states if a director, officer, or manager of the corporation directs funds to someone other than the IRS, relating to withholding taxes, they can be held responsible for the payment of those taxes. This same rule under federal law would apply to a LLC. He was not aware of them being held liable for other taxes of a corporation. Number 383 CHAIRMAN VEZEY agreed he had been referring to withholding taxes. He questioned if the manager did not make a withholding payment, and members of the board are fiducially responsible, how would it translate to a LLC. MR. BRAUTIGAN answered under current federal law a person who is responsible for making the withholding payments, who wilfully failed to pay them to the IRS, can be held responsible for the payments. Therefore, the same law applies to both a regular corporation under current status and to the LLC members. Number 400 CHAIRMAN VEZEY stated his interpretation is that the boards of directors are expected to exercise responsible oversight, and failure to do that is usually interpreted as intentional neglect. MR. BRAUTIGAN responded, from his experience with Section 6672, there has to be a flagrant disregard for the rules before the IRS will hold a person responsible. The IRS frequently claims flagrant violations; however, it usually ends up that the person either did not have the responsibility or did not willfully make the payment to someone other than the IRS. MR. BRAUTIGAN stated the example that he now sits on a board of directors; however, he does not have the authority to sign checks. Therefore, he could not be held responsible. Number 415 CHAIRMAN VEZEY clarified this analogy would extend over to the LLC. MR. BRAUTIGAN responded "absolutely." Number 418 REPRESENTATIVE THERRIAULT addressed the potential impact to the state treasury from the loss of corporate taxes. He did not believe this loss would be experienced. Because of the difficulty involved in transferring from the corporate structure to the LLC structure, he did not expect any corporations to make a structural change. Businesses that would most likely choose the LLC structure he felt would be those which would have chosen subchapter S or partnership structure on which there are no state corporate taxes applied. Therefore, the state treasury should not be impacted. When a business reaches the size where it would have paid any kind of significant corporate taxes, he believed that business would still want a pure corporate structure. Number 436 CHAIRMAN VEZEY commented corporate taxes are a misnomer because they do not just apply to corporations, they apply to any business entity. If the business has a profit operating under a business license, it would be subject to the corporate tax. He assumed that a LLC retaining earnings would be subject to the same tax. REPRESENTATIVE THERRIAULT replied the business would be treated just as a partnership would for taxes. Number 447 CHAIRMAN VEZEY questioned how a LLC would ever accumulate capital and retained earnings. Number 450 BRYAN DURRELL, CERTIFIED PUBLIC ACCOUNTANT and LAWYER, BOGLE & GATES, answered questions on CSSSHB 420. He stated taxes, under Alaska state law, the only income taxes are assessed against regular or C corporations. S corporations made the special election under the federal Internal Revenue Code to be taxed as if they were akin to a partnership, a flow through tax where the profits and losses are allocated to the shareholders. S corporations and partnerships are not subject the Alaska income tax, only C corporations. MR. DURRELL addressed CSSSHB 420 where a LLC would be formed. He stated there would be an option of the organizers to structure it either as a corporation subject to tax, or as a partnership. He believed most will opt for partnership structure for the primary tax advantage. An LLC organized as a partnership would not be subject to tax. Income would be allocated to the members and they would not have to pay taxes on it. Number 492 CHAIRMAN VEZEY clarified for a LLC, partnership, or an S corporation to accumulate capital or retained earnings, the individual partners would have to pay the taxes on the retained earnings. Number 497 MR. DURRELL affirmed CHAIRMAN VEZEY. The individual members of the LLC would pay taxes on any allocable share of the profits. Whether they were retained earnings or capital, or if they were distributed it would not matter. Number 501 REPRESENTATIVE ULMER inquired, in trying not to have a significant revenue impact to Alaska, which kinds of companies may opt to use the LLC structure in the future, thereby potentially reducing state revenues. She noted the mining and fishing companies trying to avoid state corporate income taxes. Number 519 MR. DURRELL responded he did not believe there would be any significant loss of tax revenues to the state. Mining and fishing companies which have worked within the corporate structure, could use the LLC structure. He noted they would replace their corporate structure they currently have with the LLC structure. A joint venture structure would be replaced. MR. DURRELL mentioned the example of the organization of the Greens Creek Mine, originally the largest silver mine in the United States. A joint venture was originally selected to organized by because it would give them pass through tax benefits. Mining companies could make their investments in Alaska more efficient using a LLC because they would still have the pass through tax benefits, and the limited liability aspect would be an added attraction. He explained in order to go into a project like Greens Creek, they have to form a corporate subsidiary which holds the joint venture interest in order to get limited liability. The result is a half a dozen publicly held corporations, each with fully owned subsidiaries, and each are joint venture partners. Under the new format, the corporations can avoid the intermediary fully owned subsidiary. In an LLC, they can have a membership interest without any impact on tax revenues to the state. Number 558 CHAIRMAN VEZEY asked if REPRESENTATIVE ULMER wanted to hold CSSSHB 420 for further review. REPRESENTATIVE ULMER affirmed CHAIRMAN VEZEY. Number 563 REPRESENTATIVE THERRIAULT asked when CSSSHB 420 would be reheard and if it would make the deadline for moving house bills to house rules. Number 566 CHAIRMAN VEZEY answered CSSSHB 420 would not make the deadline because it would be reheard next Thursday. He noted the companion bill in the Senate. Number 567 REPRESENTATIVE THERRIAULT pointed out the Senate bill had been held waiting the arrival of CSSSHB 420. Number 570 CHAIRMAN VEZEY noted CSSSHB 420 as a major piece of legislation and believed there would not be a problem getting a waiver for the internal rule. Senate bills will be heard until April 20. If he requested it, he believed a one-week extension would be granted. CHAIRMAN VEZEY held CSSSHB 420 in committee. (REPRESENTATIVE ULMER left the meeting at 9:31 a.m.)
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