REVENUE RULE 93-30

1993-1 C.B. 231, 1993-16 I.R.B. 4.

Internal Revenue Service
Revenue Ruling

CLASSIFICATION OF NEVADA LIMITED LIABILITY COMPANY

Published: April 19, 1993

§ 7701.  Definitions, 26 CFR 301.7701-2: Associations.

Classification of Nevada limited liability company. An unincorporated organization operating under the Nevada Limited Liability Company Act is classified as a partnership for federal tax purposes under § 301.7701-2 of the Procedure and Administration Regulations.

ISSUE

Is M, a Nevada limited-liability company, classified for federal tax purposes as an association or as a partnership?

FACTS

M is organized as a limited-liability company (LLC) pursuant to the provisions of the Nevada Limited-Liability Companies Act (Act), Nev.Rev.Stat.Ann. §§ 86.011 through 86.571 (Michie 1991). M is authorized under its articles of organization to engage in any and all business activity permitted by the laws of the State of Nevada. M has 25 members, including A, B, and C who are the elected managers under M's articles of organization.

§ 86.291 of the Act provides that, except to the extent that the articles of organization provide for management of an LLC by a manager or managers, management of an LLC is vested in its members. The members of an LLC vote in proportion to their contributions to the capital of the LLC, as adjusted from time to time to reflect any additional contributions or withdrawals. § 86.291 further provides that if management of the LLC is vested by the articles of organization in a manager or managers, the managers must be elected annually by the members in the manner prescribed by the operating agreement of the LLC.

§ 86.371 of the Act provides that no member or manager is liable under a judgment, decree or order of a court, or in any other manner, for a debt, obligation or liability of the LLC.

§ 86.351(1) of the Act provides that a membership interest in an LLC is personal property and may be transferred or assigned as provided in the operating agreement. If all of the other members of the LLC do not approve of the proposed transfer or assignment by unanimous written consent, the transferee has no right to participate in the management of the LLC or to become a member. A transferee who does not become a member is only entitled to receive the share of profits or other compensation by way of income, and the return of contributions, to which the transferor would otherwise be entitled.

§ 86.491 of the Act provides that an LLC formed under this Act is dissolved upon the occurrence of any of the following events: (1) when the period fixed for the duration of the LLC expires; (2) by the unanimous written agreement of all members; or (3) upon the death, retirement, resignation, expulsion, bankruptcy, or dissolution of a member, or the occurrence of any other event that terminates a member's continued membership in the LLC, unless the business of the LLC is continued by the consent of all the remaining members under a right to do so stated in the LLC's articles of organization. Under M's articles of organization, upon the withdrawal of a member, the consent of all the remaining members must be obtained to continue the business of M.

LAW AND ANALYSIS

§ 7701(a)(2) of the Internal Revenue Code provides that the term "partnership" includes a syndicate, group, pool, joint venture, or other unincorporated organization, through or by means of which any business, financial operation, or venture is carried on, and which is not a trust or estate or a corporation.

§ 301.7701-1(b) of the Procedure and Administration Regulations states that the Code prescribes certain categories, or classes, into which various organizations fall for purposes of taxation. These categories, or classes, include associations (which are taxable as corporations), partnerships, and trusts. The tests, or standards, that are to be applied in determining the classification in which an organization belongs are set forth in sections 301.7701-2 through 301.7701-4.

§ 301.7701-2(a)(1) of the regulations sets forth the following major characteristics of a corporation: (1) associates, (2) an objective to carry on business and divide the gains therefrom, (3) continuity of life, (4) centralization of management, (5) liability for corporate debts limited to corporate property, and (6) free transferability of interests. Whether a particular organization is to be classified as an association must be determined by taking into account the presence or absence of each of these corporate characteristics.

§ 301.7701-2(a)(2) of the regulations provides that an organization that has associates and an objective to carry on business and divide the gains therefrom is not classified as a trust, but rather as a partnership or association taxable as a corporation. It further provides that characteristics common to partnerships and corporations are not material in attempting to distinguish between an association and a partnership. Since associates and an objective to carry on business and divide the gains therefrom are generally common to corporations and partnerships, the determination of whether an organization which has these characteristics is to be treated for tax purposes as a partnership or as an association depends on whether there exists centralization of management, continuity of life, free transferability of interests, and limited liability.

§ 301.7701-2(a)(3) of the regulations provides that if an unincorporated organization possesses more corporate characteristics than noncorporate characteristics, it constitutes an association taxable as a corporation.

In interpreting § 301.7701-2 of the regulations, the Tax Court, in Larson v. Commissioner, 66 T.C. 159 (1976), acq., 1979-1 C.B. 1, concluded that equal weight must be given to each of the four corporate characteristics of continuity of life, centralization of management, limited liability, and free transferability of interests.

In the present situation, M has associates and an objective to carry on business and divide the gains therefrom. Therefore, M must be classified as either an association or a partnership. M is classified as a partnership for federal tax purposes unless the organization has a preponderance of the remaining corporate characteristics of continuity of life, centralization of management, limited liability, and free transferability of interests.

§ 301.7701-2(b)(1) of the regulations provides that if the death, insanity, bankruptcy, retirement, resignation, or expulsion of any member will cause a dissolution of the organization, continuity of life does not exist. § 301.7701-2(b)(2) provides that an agreement by which an organization is established may provide that the business will be continued by the remaining members in the event of the death or withdrawal of any member, but the agreement does not establish continuity of life if under local law the death or withdrawal of any member causes a dissolution of the organization.

Under the Act, unless the business of M is continued by the consent of all the remaining members, M is dissolved upon the death, retirement, resignation, expulsion, bankruptcy or dissolution of a member, or the occurrence of any other event that terminates the continued membership of a member in the LLC. If a member of M ceases to be a member of M for any reason, the continuity of M is not assured because all remaining members must agree to continue the business. Consequently, M lacks the corporate characteristic of continuity of life.

§ 301.7701-2(c)(1) of the regulations provides that an organization has the corporate characteristic of centralized management if any person (or group of persons that does not include all the members) has continuing exclusive authority to make management decisions necessary to the conduct of the business for which the organization was formed.

§ 301.7701-2(c)(2) of the regulations provides that the persons who have this authority may, or may not, be members of the organization and may hold office as a result of a selection by the members from time to time, or may be self-perpetuating in office. Centralized management can be accomplished by election to office, by proxy appointment, or by any other means which has the effect of concentrating in a management group continuing exclusive authority to make management decisions.

§ 301.7701-2(c)(4) of the regulations provides that there is no centralization of continuing exclusive authority to make management decisions, unless the managers have sole authority to make the decisions. For example, in the case of a corporation or a trust, the concentration of management powers in a board of directors or trustees effectively prevents a stockholder or a trust beneficiary, simply because that person is a stockholder or beneficiary, from binding the corporation or the trust.

Under the Act, an LLC may be managed either by an elected manager or managers or by its members. Under the articles of organization, M is managed by its elected managers A, B, and C; therefore, M possesses the corporate characteristic of centralized management.

§ 301.7701-2(d)(1) of the regulations provides that an organization has the corporate characteristic of limited liability if under local law there is no member who is personally liable for the debts of, or claims against, the organization. Personal liability means that a creditor of an organization may seek personal satisfaction from a member of the organization to the extent that the assets of the organization are insufficient to satisfy the creditor's claim.

Under the Act, the members of M are not liable for M's debts, obligations, or liabilities. Consequently, M possesses the corporate characteristic of limited liability.

§ 301.7701-2(e)(1) of the regulations provides that an organization has the corporate characteristic of free transferability of interests if each of the members, or those members owning substantially all of the interests in the organization, have the power, without the consent of other members, to substitute for themselves in the same organization a person who is not a member of the organization. For this power of substitution to exist in the corporate sense, the member must be able, without the consent of other members, to confer upon the member's substitute all the attributes of the member's interest in the organization. The characteristic of free transferability does not exist if each member can, without the consent of the other members, assign only the right to share in the profits but cannot assign the right to participate in the management of the organization.

Under the Act, a member of M can assign or transfer that member's interest to another person who is not a member of the organization. However, the assignee or transferee does not become a substitute member and does not acquire all the attributes of the member's interest in M unless all the remaining members approve the assignment or transfer. Therefore, M lacks the corporate characteristic of free transferability of interests.

M has associates and an objective to carry on business and divide the gains therefrom. In addition, M possesses the corporate characteristics of centralized management and limited liability. M does not, however, possess the corporate characteristics of continuity of life and free transferability of interests.

HOLDING

M has associates and an objective to carry on business and divide the gains therefrom but lacks a preponderance of the four remaining corporate characteristics. Accordingly, M is classified as a partnership for federal tax purposes.

DRAFTING INFORMATION

The principal author of this revenue ruling is Noah S. Baer of the Office of Assistant Chief Counsel (Passthroughs and Special Industries). For further information regarding this revenue ruling, contact D. Lindsay Russell on (202) 622-3050 (not a toll-free call).

Rev. Rul. 93-30, 1993-1 C.B. 231, 1993-16 I.R.B. 4.