Despite Prop Regs 1.1402(a)-2(h)(2)(i), could we argue, in Michigan, that my wife DOES NOT have liability, and is a LP?

Question

Putting 26 CFR § 1.469-5T(f)(3) & IRS Pub. 925 aside:  
 
My wife & I own 50/50 an LLC. I am the Member-Manager; my wife has no authority in the LLC, as stipulated in the Operating Agreement.  
 
Consider: 26 CFR § 301.7701-3(b)(2)(ii): …A member has personal liability if the creditors of the entity may seek satisfaction of all or any portion of the debts or claims against the entity from the member as such. 
 
BUT, Michigan is a common law state. Generally, you are liable for a debt only if your name appears on the account, your credit information was used, or it was for necessary items. If your spouse incurred a business debt, you are usually not liable unless you cosigned or guaranteed it. 
 
So, assets are not necessarily community property. Thus, it isn’t clear a creditor could satisfy claims with “our” assets.   
 
As GP, my liability is limited to the LLC; my wife is both LP & LLC-protected. Thus, can’t we argue my wife is clearly NOT liable? Thus, she could DEFINITELY be a LP?

James L. Arrasmith · Answer

Based on the information provided, it seems like you are trying to argue that your wife should be considered a limited partner (LP) in your Michigan LLC, despite owning a 50% interest, because she has no management authority and Michigan's common law system may protect her personal assets from the LLC's liabilities. 
 
However, there are a few key issues to consider: 
 
1. LLC vs. LP designation: By default, co-owners of an LLC are considered members, not limited partners. LLCs and LPs are distinct legal entities. To be an LP, the entity would typically need to be structured as a limited partnership from the outset. 
 
2. State LLC laws: Michigan's LLC Act governs the liability protection and rights of LLC members. By default, members are shielded from the LLC's debts and liabilities, regardless of their management authority. The operating agreement cannot override state law protections. 
 
3. Charging orders: Even if a creditor cannot directly seize your wife's personal assets, they may still be able to obtain a charging order against her LLC interest, entitling them to her distributions. 
 
4. IRS regulations: The IRS rules you mentioned, like 26 CFR § 1.469-5T(f)(3), provide guidelines for determining material participation for tax purposes. But they don't directly impact the legal status of an LLC member under state law. 
 
In summary, while you can certainly limit your wife's authority in the operating agreement, it's unlikely you can convert her LLC membership into a limited partnership interest simply by arguing she has no liability. Her status and rights as an LLC member are determined by Michigan's LLC statutes. 
 
The most prudent course would be to consult a Michigan business attorney to review your operating agreement and advise on the best way to structure the LLC to achieve your desired outcome. But based on the information provided, classifying your wife as a limited partner could be an uphill battle.

Q: Despite Prop Regs 1.1402(a)-2(h)(2)(i), could we argue, in Michigan, that my wife DOES NOT have liability, and is a LP?