REVENUE RULE 93-49

1993-2 C.B. 308, 1993-25 I.R.B. 11.

Internal Revenue Service
Revenue Ruling

CLASSIFICATION OF ILLINOIS LIMITED LIABILITY COMPANY

Published: July 19, 1993

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

Classification of Illinois limited liability company. Because of the flexibility accorded by the Illinois Limited Liability Company Act, an Illinois limited liability company may be classified as a partnership or as an association taxable as a corporation depending upon the provisions adopted in the limited liability company's articles of organization or operating agreement.

ISSUES

Is M, an Illinois limited liability company, classified for federal tax purposes as an association or as a partnership under § 7701 of the Internal Revenue Code?

FACTS

On January 3, 1994, M is organized as a limited liability company (LLC) pursuant to the provisions of the Illinois Limited Liability Company Act (Act), 805 ILCS 180/1-1 through 60-1. M is authorized under its articles of organization to engage in any and all business activity permitted by the laws of Illinois. M has 25 members, including A, B, and C who are the elected managers under M's articles of organization.

§ 15-1 of the Act provides that management of an LLC is vested in its members; however, if the articles of organization so provide, the management of the LLC may be vested, in whole or in part, in a manager or managers who are elected by the members in the manner prescribed by the operating agreement or articles of organization of the LLC.

§ 10-10 of the Act provides that a member of an LLC is personally liable for any act, debt, obligation, or liability of the LLC or another member or manager to the extent that a shareholder of an Illinois business corporation is liable in analogous circumstances under Illinois law.

§ 30-1 of the Act provides that an LLC interest is personal property § 30-5 of the Act states that unless provided otherwise in the articles of organization or the operating agreement, if the members of the LLC, other than the member proposing to dispose of the interest, do not approve of the proposed transfer or assignment by unanimous consent, the transferee or assignee of the interest has no right to participate in the management of the business and affairs of the LLC or to become a member. § 30-10 of the Act provides that a transferee or assignee of a membership interest who does not become a substituted member (a person admitted to all the rights and powers of a member) is entitled to receive only the share of profits or other compensation by way of income and the return of contributions to which that member otherwise would be entitled. M's LLC agreement provides that an assignee must receive the unanimous consent of the remaining members to participate in the management of the business and affairs of M.

§ 35-1 of the Act provides that an LLC is dissolved upon the first to occur of the following: (1) at the time or upon the happening of events specified in the articles of organization, (2) upon the written consent of the members which, unless otherwise provided in the articles of organization, must be unanimous, (3) unless provided otherwise in the articles of organization or the operating agreement, upon the death, retirement, resignation, bankruptcy, court declaration of incompetence with respect to, or dissolution of, a member or upon the occurrence of any other event that terminates the continued membership of a member in the LLC, unless within 90 days after the event there are at least two remaining members and all of the remaining members agree to continue the business of the LLC, (4) by the entry of a decree of judicial dissolution under the Act, or (5) by administrative dissolution under the Act. M's LLC agreement provides that M will dissolve upon the occurrence of any event that terminates the continued membership of a member in M, unless within 90 days all the remaining members of M agree to continue the business.

LAW AND ANALYSIS

§ 7701(a)(2) of the 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 that has these characteristics is to be treated for tax purposes as a partnership or as an association depends on whether there exist 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 provided otherwise in the articles of organization or the operating agreement, M is dissolved upon the death, retirement, resignation, bankruptcy, court declaration of incompetence with respect to, or dissolution of a member, or upon the occurrence of any other event that terminates the continued membership of a member in the company, unless the business of M is continued by the consent of all the remaining members. M's LLC agreement provides that M will dissolve upon the occurrence of any event that terminates the continued membership of a member in M, unless within 90 days all the remaining members of M agree to continue the business. 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 of 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 that 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 personally liable for M's acts, debts, obligations, and liabilities to the extent that a shareholder of an Illinois business corporation is liable in analogous circumstances under Illinois law. 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 of 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, under M's LLC agreement, the assignee or transferee does not become a substituted member and does not acquire all of the attributes of the member's interest in M unless all of 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

Because of the flexibility accorded by the Illinois Limited Liability Company Act, an Illinois limited liability company may be classified as a partnership or as an association taxable as a corporation depending upon the provisions adopted in the limited liability company's articles of organization or operating agreement. See, e.g., Rev.Rul. 93-38, 1993-21 I.R.B. 4 (concerning Delaware limited liability companies). M, the Illinois limited liability company considered in this ruling, is classified as a partnership for federal tax purposes because it has associates and an objective to carry on business and divide the gains therefrom but lacks a preponderance of the four remaining corporate characteristics.

DRAFTING INFORMATION

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

Rev. Rul. 93-49, 1993-2 C.B. 308, 1993-25 I.R.B. 11.