I've had a few questions about categories in Office Live Mail accounts not syncing to Outlook using the Outlook connector. This isn't a problem with Outlook or the connector but rather with the use of the term "Category" in Hotmail/Live accounts.
Hotmail lets you assign contacts to categories; Outlook lets you assign categories to contacts. So why don’t the Categories sync when you use the Outlook Hotmail Connector?
If you assign a category in Hotmail, you’ll find it does sync to Outlook – creating a distribution list of the same name in Outlook’s contact folder. DL’s sync up to Hotmail – as contact categories.
What Hotmail/Live calls "Categories", Outlook knows as Distribution lists (or Contact groups in Outlook 2010). The connector will sync the "category" into Outlook as a distribution list name but it does not sync the members, leaving you with an empty distribution list. Importing DLs has always been buggy and members rarely made it through the import so this comes as no surprise.
Distribution lists created in Outlook will correctly sync to the Live account, adding the DL members to your online contacts if the contact does not exist, and creating the "Category" containing those addresses.
Solution: Create distribution lists in Outlook and let the connector sync them to the server.