What Are the Securities Law Implications of Incentive Compensation by LLCs Taxed as Partnerships?

Welcome to the landmark 15th entry in our comprehensive incentive compensation series. As we celebrate reaching this notable milestone, we take pride in the robust knowledge base we’ve cultivated on this essential topic. In this article, we will scrutinize the complexities of securities laws and their ramifications for incentive compensation in the context of Limited Liability Companies (LLCs) taxed as partnerships. We invite you to immerse yourself in this engaging and informative exploration.

An Overview of Blue Sky Laws

The legal framework governing state-level securities regulation in the United States is commonly known as Blue Sky Laws. These laws complement federal securities statutes by emphasizing the need for companies to provide accurate and transparent information about their offerings. For LLCs taxed as partnerships, the relevance of Blue Sky Laws arises when they grant equity-based incentives, such as profit interests, capital interests, or options on capital interests, to their members. These incentives are classified as securities, making them subject to both federal and state securities regulations.

Here are some key provisions under these securities laws:

  1. Register the security offering with the appropriate state securities regulator or qualify for a state-level exemption.
  2. Ensure the provision of accurate and transparent information to investors.
  3. Comply with state-specific regulations governing the sale and distribution of securities.

Partnership-taxed LLCs can, under certain conditions, be exempted from registering securities with the SEC. These provisions fall under Rule 701, which we will examine in greater detail later. However, it is crucial to recognize that Rule 701 does not explicitly preempt Blue Sky Laws. As a result, even if a company qualifies for an exemption under this rule, it must still adhere to state-level securities regulations.

The Exemption: Rule 701

Rule 701 is a provision under the United States Securities Act of 1933 that grants private companies an exemption from registering securities issued as compensation to their members with the Securities and Exchange Commission (SEC). Here are some of the various conditions that companies must satisfy to qualify for an exemption under Rule 701:

  1. The securities must be issued as part of a written compensatory benefit plan.
  2. During a 12-month period, the value of the securities must not exceed: (a)$1 million; (b) 15 percent of the company’s total assets; or (c) 15 percent of the outstanding securities of the class being offered.

If the incentive compensation, such as profit interests, capital interests, or options on capital interests, aligns with these criteria, the partnership-taxed LLC is exempt from registering these securities with the SEC. However, the company may still need to inform the SEC of their intention to rely on Rule 701 when issuing profit interests, typically done by filing a Form D.

Implications on Incentive Compensation

As previously highlighted, profit interests, capital interests, and options on capital interests are classified as securities, making them subject to the securities regulations discussed in this article. Generally, the securities implications requiring both the company and the member to adhere to these regulations arise upon the grant of capital interests and profit interests, as well as upon the grant and exercise of options on capital interests.


We hope this article has been informative and useful for your business. If you have any questions or comments, please contact us at info@wilkinsonlawllc.com. We plan to answer general questions in an upcoming FAQ series. If you need legal advice specific to your situation, please ask to schedule a consultation with an attorney to discuss your company’s goals.

In our upcoming edition, we will explore the integration of incentive compensation into the business success planning of a partnership-taxed LLC. Stay tuned for further insights.

This article is for informational purposes only and should not be relied upon as tax advice. Please consult your tax professional for advice tailored to your specific situation. The author and publisher assume no responsibility for any errors or omissions or for any actions taken based on the information presented.